The World Post-Brexit

Jul 7, 2016 | Investment Updates

SageVest Wealth Management Q2 Investment Commentary graphic

SageVest Wealth Management recently released our quarterly commentary. Highlights are as follows:

– The Brexit vote stunned the world, raising economic, political, central bank and currency uncertainties.

– Bond investors benefited handsomely post the Brexit vote, and interest rates are now expected to remain low as central banks consider necessary stimulus efforts.

– The US economy remains fairly steady, offering encouragement for a possible resumption in growth.

After a difficult start to the year, investor confidence and stock prices had been improving throughout most of the second quarter.  Oil prices enjoyed a strong rebound; the US equity markets climbed back to their highs; and, the Eurozone’s GDP pushed above its peak of eight years ago.  The investment environment was fairly encouraging.

Then, the world woke up on June 24, 2016 and learned that the United Kingdom (UK) had voted to leave the European Union (EU). The news sent a shockwave across global investment markets.  Stocks fell sharply, namely international stocks, and the British pound began to free-fall, as investors around the world panicked.

It was a painful, but surprisingly brief, two-day period before a temporary stock rebound ensued.  By the close of the second quarter, US stocks had largely recovered from Brexit-related losses.  European stocks had also recovered, but not to the same extent.

The markets have since pulled back again. However, a four-day winning streak after the Brexit vote means investors are absorbing the impacts with varied expectations, suggesting that the long-standing effects remain largely unknown.  We explore current thoughts about the Brexit vote and other meaningful market factors.

Brexit Uncertainty

One thing that is known following the Brexit vote is that we have elevated uncertainty, a variable the markets generally don’t favor.  The list of unknowns in the UK is fairly long, including:

  • For Britain to exit the EU, they must first invoke Article 50.  No such efforts have been initiated, nor are they expected anytime before a new Prime Minister takes office in the Fall.
  • It’s unclear if Parliament will even recognize the referendum results, as it has the option to not act upon the Brexit vote.
  • Complicating things, Britain’s political system has fallen into a state of mild chaos, with turmoil in both primary political parties.
  • Some British citizens are calling for a second referendum, but with virtually no deciding government bodies.
  • Scotland and Northern Ireland voted to remain in the EU, hinting at possible future fracturing of the UK.

Some could argue that a British exit shouldn’t have a large impact on the world economy, as the UK only represents about 4% of world GDP.  Hopefully this is the case, but there are larger factors to consider.

  • We saw the turmoil that Greek exit fears brought to the markets in recent years.  Greece is a small country within the EU, whereas Britain is the EU’s second largest member.  The loss of such a valuable constituent is unknown, and it could trigger other countries to pursue exit votes.   These considerations have sadly raised questions about the long-term viability of the EU.
  • Until terms of an exit are negotiated (perhaps up to two years after Article 50 is initiated), Britain’s standing in the world remains unknown with regard to the movement of goods, services and people.  New trade and political agreements potentially remain in limbo until then as well.
  • There will also likely be some level of economic stagnation as some global business and UK consumer transactions could sit on hold, until people know how to navigate a post-Brexit world economy.

As close allies and trade partners, the UK and the EU both have vested interests in making negotiations favorable for both sides.  However, the EU faces the additional challenge of not making an exit so easy that it encourages other member countries to depart.  This dilemma, combined with the EU’s history of making slow decisions, leads us to expect a long drawn-out negotiation process, perhaps casting Brexit unknowns beyond the two year window of Article 50.  Such extended uncertainties could be deemed as downcast for the markets, and we do expect heightened volatility.  However, we also think it’s important to consider that trade and political agreements will likely operate per status quo until new terms go into effect.  If so, negotiation discussions could become passé to the markets over such a period of time, possibly making market effects more innocuous the longer the Brexit extends.

Interest Rates:  Is The World Round Or Flat?

Bonds are another hot topic this summer, as interest rates around the world have considerably flattened, or even moved negative in a few countries.  The Fed elected to leave rates steady at the last FOMC meeting, casting yields lower before a substantial rate plummet that followed the Brexit vote.  We now live in world where negative rates are becoming commonplace, and where US Treasury yields (among other global government bonds yields) have touched new historic lows.  Bond prices move inversely to yields.  As such, an ultra-low interest rate environment is rewarding for those who already owned bonds, but punishing for those now searching for bond investments.

Negative rates in the global environment are perplexing, and rightfully so, as they’re incredibly rare, and certainly unconventional.  Rates have moved into negative territory in some countries for two fundamental reasons.  The first is the intentional act of select central banks (similar to the Fed) that have begun charging banks to hold cash reserves on an overnight basis.  The objective is to encourage banks to lend money by making it too costly to hold money.  The second reason is the unintentional outcome among investors whose fears of market uncertainty and risks of deflation have escalated to a point where they are willing to pay a fee to ensure their assets are ‘safe’.  Paying for someone to hold your cash is almost unfathomable to comprehend, but represents the concerns present in some areas of the world.

From a positive standpoint, an ultra-low interest environment is part of what has spawned US growth in recent years.  Consumers have been spending more, the real estate market is strong (with incredibly low mortgage rates), and companies are engaging in activities to take advantage of these low rates.  If we look to the recent past, new ultra-low interest rates could spark a new surge in economic activity, at least domestically, and assuming Brexit or other world ripples don’t have a meaningful global impact.

US Stands Fairly Healthy

We continue to overweight US stocks, which has been healthy for investors.  Our US markets and US economy have remained fairly resilient.  First quarter GDP numbers were recently revised upward, and we think there’s a strong case for a repeat of the economy improving later in the year.  We continue to be optimistic about the US economy and stock markets, assuming that our dollar doesn’t gain too much value too quickly.  If the dollar does move higher, it could put our US companies at a pricing disadvantage.  Trying to predict currency movements in a very fluid and quickly changing currency landscape has proven to be a fool’s game over the past two years.  This is something to watch, but not something to predict.

The Outlook & Positioning

Looking forward, SageVest Wealth Management cautions investors that volatility is likely to ensue.  We also remind investors that volatility has two sides – a downside and an upside.  This is an important time to ensure that you’re ready for either outcome with the appropriate positioning to participate, protect and further invest if opportunities present.  As always, we encourage you to contact us with any questions.

Prepared by SageVest Wealth Management. Copyright .
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