Tag: market volatility

After the Brexit Vote: What Lies Ahead for the Markets?

Key Points:

  • Voters have decided that the U.K. should exit the European Union.
  • It may take some time for the shock to work through the economic, financial and political systems in the U.K. and Europe.
  • It is expected to take at least 2 years for the U.K. to formally leave the 28 nation European Union.

As we are all aware by now, Britain voted to leave the European Union (EU) yesterday, June 23, 2016. We would term this development, commonly called a “Brexit,” a market and economic shock. International developed and emerging market stocks were up in June and over the 90 days leading up to this referendum, suggesting markets were not pricing in a Brexit outcome. The initial shock of the unexpected result prompted a sharp decline in stock markets around the world, and we believe it may take some time for the shock to fully work through the economic, financial and political systems in the U.K. and Europe. With no visible catalyst to halt the slide, the decline in global stocks may continue as the risk of a recession increases.

Today is a good reminder of why we do things the way we do. We use experienced active managers (who can and will make adjustments according to occurrences like these), balanced managers who split their allocations between stocks/bonds/cash, long/short managers who have the ability to make money in a rising or falling price environment, utilize forms of guaranteed retirement income, and invest in historically non-correlated assets like real estate—just to name a few.

As a result of Brexit and the uncertainty it brings, global stocks may fall further. No two market shocks are the same, but in some of the other shocks since the financial crisis, markets have recovered in three to four months. Since the end of the financial-crisis induced global recession in 2009, a series of shocks have helped to keep growth, inflation and stock market performance subdued. The shocks that have taken place in Japan, the United States and Europe may offer us some insight into the potential duration of the market impact of Brexit. To recap, we have highlighted below the major economic impactors since the recession of 2009:

  • After the shock of a devastating earthquake and related nuclear accident in Japan on March 11, 2011, the Nikkei fell 16% during the next two trading days, but fully recovered those losses by July 8, 2011, a period of four months. It is worth noting that the lingering recession caused this initial rebound to fade into two back-to-back double-digit declines and rebounds until stocks finally recovered their losses by the end of 2012.
  • After the congressional standoff over the U.S. debt ceiling saw the S&P 500® index slide 3% on August 1, 2011, members of the House cut a deal to end it on August 2, prompting U.S. stocks to have a one-day rebound on August 3. But they fell another 12% over the next two months on fears of economic fallout, finally bottoming on October 3, 2011. The S&P 500 recouped these losses by the end of October, a period of three months.
  • The European debt crisis forced Spain to unveil an austere budget and prompted labor strikes in “too big to bail” Spain on March 27-29, 2012, and effected a shock that drove the STOXX 600 down 3%. It went on to fall a total of 11% by June 4, as the Eurozone slid into a recession. By the end of July, stocks had recovered their losses, a period of three months.

Although the Brexit is not a perfect parallel with any of the above shocks, the delayed recognition of widening impacts from shock events could prompt a further slide in the stock markets after the initial reaction, as we have seen in the past. It is important for long-term investors to note that in each of these instances stocks rebounded to their pre-shock level in three or four months, even when a recession took place. We believe maintaining our long-term strategies in diversified asset allocations will continue to help us weather volatility on the path to our long term goals.

As we look ahead, some of the widening impacts of Brexit may include:

  • Other countries calling for their own referendums on EU membership. This could put the European Central Bank in a difficult position to continue their quantitative-easing program of buying the bonds of countries that may choose to leave the Eurozone. It’s not hard to see France’s Marine Le Pen taking the same path as Britain, should she win the election in less than a year from now. A “Frexit” could be even bigger than Brexit in its impact on markets, with a European Central Bank that may be unable to effectively intervene.
  • A battle may begin among those who want to replace U.K. Prime Minister David Cameron, who has announced he will step down in a few months, with each candidate arguing he or she will be most aggressive in negotiations with the EU. In response, the EU leaders in Brussels will make it clear they intend to be tough on the U.K. to make them an example. As the rhetoric heats up, the markets may become increasingly pessimistic regarding a trade deal that could be mutually damaging. Negotiations could drag out for years.
  • A rise in the U.S. dollar, as investors seek safe havens, would likely contribute to declines in commodity prices. This may renew cuts to earnings estimates and prompt an eventual devaluation of the Chinese yuan versus the U.S. dollar. These factors, combined with slower export growth to Europe (China’s biggest customer), may renew concerns about an economic hard landing for China. In addition, a rise in the dollar could add pressure on emerging market stocks due to concerns about dollar-denominated debts and tighter financial conditions.
  • A return to recession in Europe as fear of a breakup begins to slowly impact capital investment, hiring, and consumption.

With all of this said, we do not believe “Brexit” to be the real issue. By itself, Brexit is likely not a major issue for the global economy. The real issues are political volatility, global economic fragility, and the prospect of the world economy tilting into recession. If the economy does not fall into a recession, markets are likely to bounce back in the short term.

We will have additional comments as warranted and will also send you comments directly from the experienced managers that you are personally invested with. For now, we see this as one event in a series of constant and ongoing global economic events and no reason for panic. Nonetheless and as always, we will be watching developments and will remain vigilant.