Brexit Effects on Us, Thoughts Going Forward
What a wild last five days in the market, huh? Today (Tuesday) we are seeing the major indices in the green. The real question is if this is a bottom or just a breather with more downward pressure to come.
The data and information below come from a research firm I subscribe to called the Sherman Sheet.
In the markets:
The event that was never supposed to happen, happened. In a surprise upset, the people of the United Kingdom voted in favor of leaving the European Union. This triggered an avalanche of selling across global markets, all of which had rallied in anticipation of the “sure thing” win for the “Remain” side. On Friday the Dow plunged -610 points, erasing substantial gains from earlier in the week and a lot more, closing at 17,400, down -1.55%. The tech heavy NASDAQ composite fell -92 points, ending the week at 4,707, down -1.9%. The LargeCap S&P 500 dropped ‑1.63%. MidCaps and SmallCaps also lost ground, with the S&P 400 MidCap index giving up -1.5%, and the Russell 2000 small cap index also lost -1.5%. In a flight to safety, the defensive Utilities sector managed to avoid much of the carnage, down only -0.13%. The week’s declines brought the S&P 500, the Dow Jones Industrials, and the small cap Russell 2000 index all back into negative territory for the year to date (where the NASDAQ already was).
In foreign markets, the huge drop in the value of the British Pound was the single biggest move, hitting the lowest level versus the U.S. dollar since 1985.
My thoughts on the events of last week:
US investors are reacting to fears about some of the following key issues that are coming from the vote last Thursday:
The first of these being the stability of the remaining EU countries – how many will remain? Some talk has begun to surface of Scotland and Northern Ireland attempting to veto the “Leave” vote and remain in the EU – which puts into question the unity of the U.K. Secondly, the stability of the political leadership in the U.K. remains unsteady. Prime Minister David Cameron has stated he will step down in October. Until then, apparently the U.K. will not officially start the exit process. He says he will leave that up to his successor. Lastly, the U.K. has a large amount of sovereign debt and with a weak pound they could have a hard time raising investor dollars to service that debt.
So what does all of this have to do with us? Well…it could drive US interest rates even lower as more money pours into US currency and our government bonds, fleeing investment in Europe. It’s also a risky time to be long in bonds because they have run up in price already. However, lower interest rates mean good things for the US consumer, and bad things for US financial institutions who derive their profits on interest rate spreads. So, from a sector stand point, we are staying away from financials currently. It may take only a few weeks before the fear and instability of this historic vote to work themselves out of the markets in the US. Historically, July is the 2nd best month in the market. It would not be uncommon for us to see a nice rally in the coming weeks.
We are watching several key indicators for a re-entry point in the current pull back. The investor fear index, we call it the VIX, spiked in the week prior to the vote, and is still at what we consider a high level. Once it starts living in the 12 – 14 range it will indicate more calm in investor sentiment. Another important indicator, the Put/Call ratio, is a measure of contracts to sell stocks versus contracts to buy stocks (in the future). As the ratio increases it suggests that there are more investors bearish on the market than bullish. The Put/Call ratio is high currently. We are also monitoring asset flows into key ETF’s. At the end of the day the price of any item for sale is truly dependent on what someone else is willing to pay for it. Whether stocks, homes, cars or any other item – it comes down to supply and demand. When assets are flowing OUT of stock index ETF’s the prices are bound to continue to fall.
Stay tuned, it’s definitely never a dull moment, even as we approach our mid-summer break for Independence Day. Have a safe and wonderful Fourth with your family and friends this coming weekend.
Material discussed is meant for general illustration and/or informational purposes only and it is not to be construed as investment, tax or legal advice. Although the information has been gathered from sources believed to be reliable, please note that individual situations can vary. Therefore, the information should be relied upon when coordinated with individual professional advice.