Brexit Vote: What Lies Ahead for Markets? | Winfield Estates

• 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 vote 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.

As we look ahead, some of the widening impacts of Brexit vote 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 the Brexit vote 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.

Signs to watch for that may indicate the impact of the Brexit vote shock is beginning to lift

1. Economic: If the Bank of England and ECB stabilize financial conditions and the U.K. and eurozone economies capitalize on the weakness in their currencies to ease the slowdown/recession, the economic data may be near an inflection point.
2. Political: When the surge in political upheaval in Europe catalyzed by the Brexit vote settles down. Events to watch include referendum announcements in other countries and the results of the vote on a new government in Spain over the weekend, along with an Italian constitutional reform referendum in October and the polling on the upcoming 2017 French and German elections.
3. Currency: When we see an end to the flight-to-quality in the U.S. dollar and yen. The yen has been the best-performing currency at times of heightened uncertainty lately. The lack of action from the Bank of Japan at the June policy meeting is allowing appreciation pressure to continue to build up. While the yen’s move higher is negative for Japanese stocks, which have moved in lock step with the yen for five years now, an end to the rise in the yen may signal the worst is over.

What should investors do?

Short-term focused traders should be prepared for further stock market declines over the next three to six  months, similar to past shocks. We continue to believe volatility will remain a major characteristic of markets in 2016. However, longer-term investors may want to maintain their diversified asset allocations intended to weather volatility on the way to longer-term goals.

Brexit Vote Article provided by:

Jeffrey Kleintop – June 24, 2016

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