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A Ripple from Across the Pond

| June 27, 2016
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MPCA Weekly Market Update

How many of us have heard the advice to “go sleep on it?” It’s a common refrain, designed to help avoid rash decisions, to let “cooler heads prevail,” and to draw out collective wisdom. The markets have now had a weekend to sleep on the shock of the “Brexit” decision, and it appears there is no more love for the resulting uncertainty than there was in the initial reactions on Friday. As I write this, the S&P 500 is down 1.54% - earlier today dropping below the 2000 mark for the first time since March 11. The ACWI (all-country world index) is down 1.75%, reflecting a greater deterioration in market prices outside the US. 

We issued a special update on Friday regarding the Brexit decision. If you have not yet read it, you can access it right here on our blog (click here). As we wrote about in that piece, much of the downturn in the markets is a result of a heavy infusion of uncertainty. There simply is no precedent for a move of this type and magnitude, and investors are worried that a shock of this nature on the backs of an already slowing global economy and a turbulent political environment could prove difficult to withstand. In the midst of a lot of guessing, the only fact that is clear at this point is that nobody knows the exact implications of “Brexit.”

One implication we have seen in the short-term is a marked “flight to safety” in the capital markets on Friday. One key landing spot for this “safe money” was US government debt. By the close Friday, yields on US treasuries were near record lows, as investors piled in and huddled down as they wait to see the continued ramifications from Thursday’s surprising vote. This was a contrast to movement earlier in the week. Yields actually finished higher last Monday, stalling record-shattering declines in bond yields which had sent the German 10-year bond below zero for the first time on record. Prices of US government bonds pulled back further (and thus yields increased) on Tuesday after a five-year note auction drew relatively poor demand. However, by Friday, the picture was significantly different, and that movement continues today. 

On the equity side, US stocks ended the week with their biggest one-day drop in 10 months (-3.59%). However, if you take a step back and look at the week as a whole, the S&P 500 was down a more modest -1.63%, as equities had rallied earlier in the week in (incorrect) anticipation of a “remain” vote from the UK. Things were obviously worse across the pond, where the Euro Stoxx 50 Index fell 8.62% and the FTSE 100 Index declined by 3.15% following the vote.

Another significant move on Friday was the steep decline in the value of the Pound Sterling (GBP), which closed the week down 5.5%. The GBP now stands at ~1.31£/$, its lowest mark since the mid-1980s. If you have plans to travel to London, your fish & chips just got much cheaper. On the less fun side of this coin, the strengthening of the USD ($) can be construed as an effective tightening of monetary policy since it will tamp down inflation and crimp the earnings prospects of US multinationals, which will in turn hold back business investment. Most traders now agree that a rate hike by the Fed is likely off the table for the remainder of this year, barring a significant improvement from these early reactions to Brexit. 

In what seems like a timely reassurance, it was announced that all 33 of the biggest US banks passed the Federal Reserve’s stress test. Each bank is put through a number of hypothetical tests to examine if they have enough capital to weather a severe economic shock.

Lost in the shuffle last week seemed to be news from the US front. On a positive note, sales of previously owned homes rose to the highest level in over nine years in May. At the same time, new home sales declined after reaching an eight-year high last month. Overall housing demand continues to show signs of improvement as a firm labor market, rising wages, and low interest rates have helped support growth in residential real estate. On the negative side, orders for U.S. capital goods dropped unexpectedly in May by the most in three months, illustrating the weakness in investment even before the UK decision to leave the EU damaged confidence. The decline was primarily due to military aircraft and motor vehicles.

We will conclude by saying we are still in the initial stages of sifting through the implications of Brexit (if it even happens…). As one trusted source put it, “Depending on what source one chooses to read, the UK vote is either an act of political courage, an act of economic ignorance, a cause for other EU countries to follow suit, a cause for the remaining EU countries to band together more strongly, a catalyst for a global recession, a basis for providing more monetary and fiscal stimulus, or an early warning signal of how a sense of nationalism/protectionism could shape the election outcome in the U.S. in November” (Briefing.com). At MPCA, we do not know exactly how this will play out, but we do know we have a planning and investment process that should help you weather the storm until some clarity is available. 

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