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Brexit Rattles the Markets, Again

| June 20, 2016
MPCA Weekly Market Update

Last week was a tough one for the markets as global equities wrestled with the possibility that the United Kingdom may vote to leave the European Union this coming Thursday. The S&P 500 Index posted a negative 1.12% return. The widely followed index has returned 2.42% year to date, but has declined 1.11% in the month of June, as macro uncertainties have caused many investors to retreat to the sidelines. Risk aversion as measured by the Chicago Board Options Exchange Volatility Index (VIX) rose to 19.41 from 16.02 last week, while the yield on the 10-year US Treasury note slipped to 1.60% from 1.64% as “flight-to-safety” buying took hold.

Skittish investors had begun the week waiting for retail sales data, industrial production data, housing data and the Federal Open Market Committee (FOMC) meeting later in the week.  May retail sales data reported higher than expected on Tuesday and small business optimism also reported slightly higher than expected. With investors’ concerns over foreign markets and the FOMC meeting the following day, the positive data did little for the index as it declined 17 basis points. Wednesday brought mixed economic data with better than expected manufacturing, but slightly worse than expected industrial production. The Fed kept rates unchanged and the S&P 500 Index declined 18 basis points.

The S&P 500 Index had its only positive day of the week on Thursday, returning 0.33% - with all sectors, excluding energy, showing positive performance.  Domestic initial jobless claims of 277K were higher than the consensus estimate of 270K and higher than the previous week’s 264K.  Unfortunately, stocks were back on the decline on Friday as the S&P 500 Index returned -0.33%.  Crude oil closed the week at $47.98 a barrel, declining -2.22% from the previous week’s close. Eight of the ten economic sectors had negative performance for the week.

As previously mentioned, the Federal Open Market Committee last week voted unanimously to keep rates unchanged and indicated that the path for future rate hikes will likely be more gradual than the committee had forecast in March. Meanwhile, global counterparts the Bank of Japan, the Bank of England, and the Swiss National Bank (SNB) all held policy steady.

The “Brexit” drama took a horrendous turn last week. A clear swing in opinion polls in favor of the ‘Leave’ camp had put markets on edge, when stunningly, the campaign came to a halt with the horrific news that Labour member of Parliament Jo Cox was murdered during a meeting with constituents. Earlier in the week, the Sun, the United Kingdom's largest newspaper, urged readers to vote for the UK to leave the EU, which added to intensifying risk aversion in the markets.

China weighed in with sobering news on the growth side. While retail sales and industrial production data met market expectations, fixed asset investment was weak, raising concerns that China may not be able to sustain its 6.5%–7% growth target this year. Separately, the International Monetary Fund (IMF) warned that China's rapidly rising corporate debt burden clouds its economic outlook. Adding insult to injury, index provider MSCI again decided not to include mainland China A shares in its Emerging Markets Index.

In yet another blow to global growth prospects, Germany joined the negative yield club, with the yield on 10-year German bunds dipping below zero for the first time and Swiss 30-year bonds doing the same. UK 10-year gilts fell to a record low of 1.10%.

Software giant Microsoft added LinkedIn to its professional network, announcing a deal to buy the business social network for $26.2 billion in cash. In the wake of the announcement, credit rating agency Moody's Investors Service said it was putting Microsoft's credit rating on review for a downgrade. Incidentally, Microsoft is one of only two AAA-rated corporations left in the United States. Though Microsoft has over $100 billion in cash on its balance sheet, the company said it would borrow the bulk of the purchase price in order to avoid the 35% US corporate tax rate it would pay if it repatriated cash held overseas.

Finally, some good news. Evidently, coffee doesn't cause cancer after all. After labeling Seattle’s most famous drinkable icon a carcinogen 25 years ago, the World Health Organization this week reversed course and said not only does coffee not cause cancer, it may actually guard against certain cancers. Not that any of that matters to this writer’s spouse, and countless millions, who had no intention of curtailing their caffeine intake either way. But now we can all rationalize the health benefits of our morning addiction, just as we have been doing with our evening addiction in the red form for years. Cheers!