Download Brexit Vote: The Market Impact

ECONOMICINSIGHTS
BrexitVote:TheMarketImpact
June24,2016
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GreatBritain’sdecisiontoleavetheEuropeanUnionsparkedvolatilityinglobal
marketsonJune24.
Withlastnight’spublicref erendumvotestallied,GreatBritainbecamethef irstcountryinthe
EuropeanUnion’s(EU)60-yearhistorytoleavetheEUblocof nations—amomentousdecision
withenormousconsequencesf orf inancialmarkets,theeconomy,politics,andbusiness.Itseems
appropriatethattheU.K.mediaarecallingit“IndependenceDay,”consideringthef ireworkstaking
place.
Thevoteto“leave”theEUrattledglobalf inancialmarkets,whichhadlargelyexpectedBritonsto
vote“remain,”andsenttheBritishpoundtoa30-yearlow,losing-12.4%againsttheU.S.dollar
evenbef oretheof f icialresultswereannounced.Stockmarketsaroundtheglobeweredown
signif icantlyimmediatelyaf terthevote,withDowIndustrialf uturespredictinga-800starttothe
day.AcrossEurope,banks,builders,travel,insurance,andrealestatestocksdeclinedby-10%or
more.Def ensivestocks,suchasf oodsandhealthcare,werethebestof theworst,withlossesof
just-4%.(BydaybreakintheUnitedStates,marketshadrecoveredsomewhat,oncetheinitial
shockof thevotewasabsorbed.)
So-called“saf ehaven”or“risk-of f ”betsdominatedtrading;spotgoldpricessoared;theJapanese
yenandU.S.dollarwerepushedhigheragainsttheirmajorcompetitors;demandf orU.S.
Treasuriessoared.TheyieldontheGerman10-yearbunddroppedtoanegative-0.074%.
TheU.K.’sdecisiontoleavetheEUaf ter43yearswillhavewiderepercussionsbeyondthe
f inancialmarkets,themostimmediateof whichwastheannouncementbyPrimeMinisterDavid
CameronthathewouldresigninOctober.Meanwhile,Standard&Poor’ssaiditwillbereviewing
thenation’s‘AAA’creditratingf orapossibledowngrade.Andthepossibilityof otherEU-member
nationsplanningsimilarexitsaddsanotherdestabilizingf orcetoglobalmarkets.
Moreover,aswewritethis,centralbanksaroundtheglobeareholdingemergencymeetings,anda
numberhavealreadyintervenedincurrencymarketstostemanydrasticdeclines.Asthef if th
most-heldreservecurrencyintheworld,theBritishpound’simportanceinworldmarketscannotbe
exaggerated.Itisthemosttradedcurrencyinthef oreignexchangemarket,af tertheU.S.dollar,
theeuro,andtheJapaneseyen.TogetherwiththosethreecurrenciesandtheChineseyuan,it
f ormsthebasketof currenciesusedtocalculatethevalueof theInternationalMonetaryFund’s
SpecialDrawingRights,withan8.09%weighting(asof 2015).
WhatDoesAllofThisMeanforInvestors?
WebelievethedecisiontoleavetheEUwillbeaheadwindf orbothGreatBritainandtheeurozone
economiesandtheirrespectivef inancialmarkets.WhileintheUnitedStates,however,internally
driveneconomicgrowthshouldprovidesomeinsulationf ordomesticstockandbondinvestments.
Loweryieldsproducedbycentralbankliquidityef f ortsshouldalsotranslateintoglobalinterestin
U.S.domesticdebtof allqualities.
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So,investorsconcernedabouttheimpactonnon-U.S.marketsandeconomiesmightwantto
considerincreasingtheirallocationtoU.S.stocksandbonds.FactSetreportsthatU.S.companies
derivejust2.9%of theirrevenuef romGreatBritain.Onesweetspotf orinvestorsmaybeinU.S.
mid-andsmall-capstocks,wherethegreatestexposuretotheresilientU.S.consumeristypically
f ound.Anotherpotentialinvestmentopportunitymaybef oundinU.S.high-qualitydividendgrowthstocks,whichhistoricallyhaveaidedinvestorsduringperiodsof volatilityandmarket
decline.Finally,themarketsell-of f itself maypresentinvestmentopportunity,particularlyina
slow-growtheconomicenvironmentwhenseculargrowthindustriessuchasbiotechandInternet
retailmaydistinguishthemselvesf romthebroadmarketandrewardlong-terminvestors.
Onthef ixed-incomeside,astheshockof the“Leave”votef ades,andinvestorsrealizeinthe
comingweeksthatthereisn’tasignif icantriskof aglobalrecession—andthatthereisevenless
riskwhenitcomestoU.S.companies—theymayrealizethatU.S.high-yieldbondscanprovide
neededincomewhenit’sabsenteverywhereelseintheworld.
Whatothersegmentsof thef ixed-incomemarketmayproveattractiveinthepost–Brexitperiod?
Wethinkshort-durationandotherinvestment-gradesecuritiesandmunicipalbonds—anotherU.S.centeredassetclass—alsowillbewellpositionedinthecomingmonths.Aswenotedinanearlier
article,municipalbondshaveprovidedanoasisof calmduringrecentperiodsof marketvolatility.
Unlikeothermarketsthatarebeingwhipsawedbyf ast-movingglobaldevelopments,municipal
bondsareinf luencedlargelybyf undamentalf actorsthatareU.S.f ocused.Thesearethehealth
of theU.S.economy,andsupply/demandf actors,eachof whichcontinuestoprovidesupportf or
theassetclass.
Awordof caution,however:Investorscanexpectthatcapitalmarketswillbef illedwithuncertainty
andvolatilityinthenearterm,whichmayincreasethetemptationtotimethemarket.Historyhas
shown,however,thatmarkettimingisariskyapproach.Theequitymarketsrewardthosewhostay
investedf orthelongterm.Inf act,missingjustasmallnumberof dayswithstrongperf ormance
canhaveanoutsizedimpactonaninvestor’sportf olio.
Staycalmandstayinvested.Wewillcontinuetokeepyoupostedinwhatislikelytobeahighly
turbulentmarketoverthenextweek.
Thevalueof investmentsinf ixed-incomesecuritieswillchangeasinterestratesf luctuateandinresponsetomarket
movements.Generally,wheninterestratesrise,thepricesof debtsecuritiesf all,andwheninterestratesf all,prices
generallyrise.Bondsmayalsobesubjecttoothertypesof risk,suchascall,credit,liquidity,interest-rate,and
generalmarketrisks.Foreigninvestmentsgenerallyposegreaterrisksthandomesticinvestments,includinggreater
pricef luctuationsandhighertransactioncosts.Specialrisksareinherentininternationalinvesting,includingthose
relatedtocurrencyf luctuationsandf oreign,political,andeconomicevents.Further,investinginthesecuritiesof
issuerslocatedincertainemergingcountriesmaypresentagreaterriskof lossresultingf romproblemsinsecurity
registrationandcustodyorsubstantialeconomicorpoliticaldisruptions.Thevalueof investmentsinequitysecurities
willf luctuateinresponsetogeneraleconomicconditionsandtochangesintheprospectsof particularcompanies
and/orsectorsintheeconomy.Noinvestingstrategycanovercomeallmarketvolatilityorguaranteef utureresults.
Marketf orecastsandprojectionsarebasedoncurrentmarketconditionsandaresubjecttochangewithoutnotice.
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