Weekly Note
Check here for our weekly review on the market.
Friday, June 24th, 2016
“Surprise ‘Brexit’ vote rattles global markets”
The United Kingdom’s surprise vote to leave the European Union (EU) has potentially set in motion a period of long-lasting political and economic consequences that markets are trying to digest this morning.
Preliminary polls had given the ‘Bremain’ contingent optimism that the U.K. would stay in the EU which contributed to the rally in global risk assets over the past week. Now that the votes have been tallied to the contrary, global currency, fixed income and equity markets have to re-price the potential mess that will likely unfold in the U.K. over the next couple years.
With trade agreements and business spending caught in the crosshairs of uncertainty, there could be economic consequences that result from the cloudiness in this process. The direct impact of a U.K. economic slowdown on U.S. businesses should be inconsequential, with the U.K. providing only around 0.7% of U.S. Gross Domestic Product (GDP)1. The real question remains whether other countries within the EU will feel emboldened to commence their own referendums and set in to motion a larger dissolution to the economic union.
The stronger Yen may provide a headwind for Japanese businesses, and the same could be said about the rally in the greenback on U.S. businesses. Regardless, any large scale indiscriminate selling in stocks in the U.S. and Asia should be met with opportunistic buying as the direct impact appears minimal and both regions remain amply supported by easy monetary policy. The aftermath of the vote and volatility in global markets this morning should be interpreted more as a correction to inaccurate market expectations and ambiguity on some of the potential impacts. Investor sentiment despises uncertainty.
Now that the U.K. has voted ‘Brexit’, there remains several hurdles for the actions to actually take effect. Triggering what is known as Article 50, formally notifying intension to withdraw, starts a two-year clock running. After that, the Treaties that govern membership no longer apply to Britain and terms of the exit must be negotiated between Britain’s 27 counterparts, each with their own potential veto over the conditions. Being as the U.K. is the first country to potentially depart, the true fallout process is opaque and could just as well get stymied by national parliaments or other parties to the process.
Other EU members, such as Germany, benefit from being part of the European Union due to advantageous trade agreements and a shared currency. In Germany’s case, the Euro currency is much weaker than if Germany retained its Deutsche Mark, which allows for more competitive dynamics for German exports. That is a bit different than the U.K. which retained its own currency despite being part of the EU. Nevertheless, the populist support for certain issues, namely immigration reform, have gained increased momentum and make the viability of the union less certain.
The doubt around trade agreements is why many fear economic consequences for the U.K. since businesses typically curb spending when uncertainty increases and new unfavorable trade agreements could present headwinds to economic growth. On the other hand, U.K. multinationals will now have a windfall from the Pound’s selloff on any profits brought in from abroad.
The S&P 500 futures traded limit down at one point Thursday evening, which means pre-market trading stopped once futures declined over 5%. Since stocks had rallied 3 of the past 4 trading days, leaving the S&P 500 within 1% of its all-time closing high, today’s selloff only corrects this recent rally and leaves us back to levels we saw just last week. The initial flight-to-quality reaction across asset classes has been exacerbated by this recent market rally and misplaced confidence in the ‘Bremain’ victory.
On the bright side, the British pound is now trading at levels to the U.S. dollar not seen in over 30 years. So if you ever wanted to book that tropical getaway to London you’ve been thinking about, now might be the time.
Jack Holmes, CFA® & Todd Feltz, CFP®, CFS®
WealthPLAN Partners
Sources:
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which Investment(s) may be appropriate for you, consult your financial advisor prior to investing. Information is based on sources believed to be reliable, however, their accuracy or completeness cannot be guaranteed. Statements of forecast and trends are for informational purposes, and are not guaranteed to occur in the future.
Stock investing involves risk including loss of principal. International investing involves special risks such as currency fluctuation and political instability and may not be suitable for all investors.