MARKET & ECONOMY
Much like in the first quarter, the stock market sold off sharply in the second quarter, only to end up with positive returns. It was the United Kingdom’s vote to exit the European Union, referred to as “Brexit,” that shook the markets. The market reacted severely in the two trading days following the June 23rd vote. The S&P 500 fell 5.3% but then staged a nearly-as-impressive recovery over the last three days of June to end up 2.46% for the quarter and 3.84% for the year. The S&P 500 has now posted gains in the last three quarters in a row. Despite worries about rising interest rates in early 2016, bonds have remained strong as the 10-year US Treasury yield has fallen by a third to 1.49% during the first six months of the year.
The three C’s (China, Commodities and Central Banks) that drove volatility early in the year all quieted down in the second quarter. China is still muddling through its economic transformation and while Chinese stocks haven’t recovered, prices have stabilized since January’s decline. Commodity prices posted much better returns in the second quarter, led by oil. West Texas intermediate crude oil posted a 26% gain during the second quarter. Central bank worries have also abated somewhat as it now looks like the Federal Reserve may only raise rates once in 2016, if at all. The three C’s have all taken a back seat to Brexit, which has completely dominated financial news recently.
IMPLICATIONS OF BREXIT
Leading up to the June 23rd vote, British sources were citing as much as a 90% probability that UK citizens would vote to remain in the EU. Experts and politicians alike were surprised by the vote. UK Prime Minister David Cameron immediately announced he would resign his post and step down in October.
Looking ahead, exiting the EU is not something that happens overnight. The process doesn’t even start until the UK invokes the never-used “Article 50” of the Lisbon Treaty. The vote itself is not legally binding and must be approved by the UK parliament. Outgoing Prime Minister Cameron has said he will leave the decision to trigger Article 50 to the new prime minister, so we are at least a few months away from formalization of the exit. Two leaders of the movement to leave the EU, Boris Johnson and Michal Gove, have both said Article 50 does not need to be invoked immediately and may even be delayed for several years.
Once invoked, however, it will still be two years before the UK officially leaves the EU. Following the immediate shock of the vote, it is clear that Brexit is only just beginning and there won’t be any immediate changes for trade in the EU and the UK.
But in the near term, the UK and the remaining European Union countries are left with considerable political uncertainty. With Cameron set to step down, there are questions about who will be the next prime minister. The new PM will then begin the lengthy negotiations with a 90% probability that UK citizens would vote to remain in the EU. Experts and politicians alike were surprised by the vote. UK Prime Minister David Cameron immediately announced he would resign his post and step down in October.
Looking ahead, exiting the EU is not something that happens overnight. The process doesn’t even start until the UK invokes the never-used “Article 50” of the Lisbon Treaty. The vote itself is not legally binding and must be approved by the UK parliament. Outgoing Prime Minister Cameron has said he will leave the decision to trigger Article 50 to the new prime minister, so we are at least a few months away from formalization of the exit. Two leaders of the movement to leave the EU, Boris Johnson and Michal Gove, have both said Article 50 does not need to be invoked immediately and may even be delayed for several years.
Once invoked, however, it will still be two years before the UK officially leaves the EU. Following the immediate shock of the vote, it is clear that Brexit is only just beginning and there won’t be any immediate changes for trade in the EU and the UK.
But in the near term, the UK and the remaining European Union countries are left with considerable political uncertainty. With Cameron set to step down, there are questions about who will be the next prime minister. The new PM will then begin the lengthy negotiations with the EU to determine what an exit will look like.
Both the EU and the UK are highly dependent on each other as trade partners but EU officials have made it clear there will be no special treatment for the UK, in large part to deter similar referendums in other EU countries. According to German Chancellor Angela Merkel, “There must be and there will be a palpable difference between those countries who want to be members of the European family and those who don’t.”
Across Europe, there are questions about other potential referendums. Scottish citizens voted overwhelmingly to stay in the EU and First Minister Nicola Sturgeon has talked about the possibility of another independence referendum. Since the June 23rd vote, there have been calls for referendums to determine EU membership in France, Italy, Holland, and Denmark. Should these countries leave, it would be more destabilizing than the UK leaving because each of these countries use the Euro as their currency. The UK never adopted the Euro, preferring to maintain the pound sterling as its currency.
Central banks around the world, including the Bank of England, European Central Bank, Bank of Japan, and the US Federal Reserve have all voiced their willingness to stimulate growth and provide liquidity to the global economy through further monetary policy. As you can see, central bank rates around the world are now expected to stay about the same or fall over the next two years. The US Federal Reserve is the only central bank expected to significantly raise rates over that time but only by 0.23%- -far different from the 1.00% per year increase the Fed was projecting coming into 2016.
FOCUS IS STILL ON THE FED IN THE US
It is difficult to predict what kind of impact, if any, Brexit will have on our economy. While growth prospects in Europe may be diminished, our trading status with the EU and the UK isn’t likely to be significantly affected. Only 13% of US GDP comes from foreign trade; it’s the actions of the Federal Reserve Bank that are more likely to have a significant impact on our economy.
On several occasions over the last two years the Fed has said it was going to raise rates, and then has failed to do so. As a result, we’ve seen counter-intuitive market turmoil: the market has gone up on disappointing economic reports and has slipped on good news, as investors anticipate the effect of the economic news on the Fed’s decisions. This phenomenon reappeared in the middle of June as the market fell just as some economic reports came in better than expected, suggesting the Fed may raise rates soon. However, the Brexit vote quickly pushed estimates of the next rate hike out as far as 2018, according to some estimates. The Fed’s Open Market Committee decided in April and again in June to delay raising rates, so the current period of historically low rates may well continue. Meanwhile, the US economy has been performing solidly. The Atlanta Federal Reserve Bank is estimating a 2.6% growth rate for GDP in the second quarter, well above the 1.1% rate seen in the first quarter.
LOOKING AHEAD
As the chart to the right shows, market shocks have been fairly common in recent years. The last four shocks prior to Brexit were all short-lived. It just goes to show that immediate reactions to news aren’t always great predictors of which direction the market is headed.
Undeniably, the landmark vote in the UK to leave the European Union creates a lot of uncertainty. Who will be the new UK prime minister to lead the exit negotiations? Will the EU make an example of the UK to the detriment of both sides? Will we look back at this vote as the beginning of the end for the European Union? Will central banks around the world push interest rates even lower? Does this really matter for global growth?
We won’t have answers to all of these questions for quite a while. We do know that the UK is still a part of the EU for a least a couple years. Over that time, however, we are likely to see additional spikes in volatility that have been more and more common in recent years even as the market has kept rising.
Ultimately, headline news tends to cause short-term market movements, but long-term market returns are driven by company earnings. Here the indications are hopeful. Earnings for S&P 500 companies have fallen for the last five quarters, even as the stock market has risen 5.3%. But earnings are projected to begin growing again in the third quarter and further accelerate in the fourth quarter as shown in the nearby chart. And in the end, earnings growth should trump even Brexit for its impact on investment returns.
2nd Quarter 2016: First Aid Kit
June 30, 2016Donor-Advised Funds
August 1, 2016MARKET & ECONOMY
Much like in the first quarter, the stock market sold off sharply in the second quarter, only to end up with positive returns. It was the United Kingdom’s vote to exit the European Union, referred to as “Brexit,” that shook the markets. The market reacted severely in the two trading days following the June 23rd vote. The S&P 500 fell 5.3% but then staged a nearly-as-impressive recovery over the last three days of June to end up 2.46% for the quarter and 3.84% for the year. The S&P 500 has now posted gains in the last three quarters in a row. Despite worries about rising interest rates in early 2016, bonds have remained strong as the 10-year US Treasury yield has fallen by a third to 1.49% during the first six months of the year.
The three C’s (China, Commodities and Central Banks) that drove volatility early in the year all quieted down in the second quarter. China is still muddling through its economic transformation and while Chinese stocks haven’t recovered, prices have stabilized since January’s decline. Commodity prices posted much better returns in the second quarter, led by oil. West Texas intermediate crude oil posted a 26% gain during the second quarter. Central bank worries have also abated somewhat as it now looks like the Federal Reserve may only raise rates once in 2016, if at all. The three C’s have all taken a back seat to Brexit, which has completely dominated financial news recently.
IMPLICATIONS OF BREXIT
Leading up to the June 23rd vote, British sources were citing as much as a 90% probability that UK citizens would vote to remain in the EU. Experts and politicians alike were surprised by the vote. UK Prime Minister David Cameron immediately announced he would resign his post and step down in October.
Looking ahead, exiting the EU is not something that happens overnight. The process doesn’t even start until the UK invokes the never-used “Article 50” of the Lisbon Treaty. The vote itself is not legally binding and must be approved by the UK parliament. Outgoing Prime Minister Cameron has said he will leave the decision to trigger Article 50 to the new prime minister, so we are at least a few months away from formalization of the exit. Two leaders of the movement to leave the EU, Boris Johnson and Michal Gove, have both said Article 50 does not need to be invoked immediately and may even be delayed for several years.
Once invoked, however, it will still be two years before the UK officially leaves the EU. Following the immediate shock of the vote, it is clear that Brexit is only just beginning and there won’t be any immediate changes for trade in the EU and the UK.
But in the near term, the UK and the remaining European Union countries are left with considerable political uncertainty. With Cameron set to step down, there are questions about who will be the next prime minister. The new PM will then begin the lengthy negotiations with a 90% probability that UK citizens would vote to remain in the EU. Experts and politicians alike were surprised by the vote. UK Prime Minister David Cameron immediately announced he would resign his post and step down in October.
Looking ahead, exiting the EU is not something that happens overnight. The process doesn’t even start until the UK invokes the never-used “Article 50” of the Lisbon Treaty. The vote itself is not legally binding and must be approved by the UK parliament. Outgoing Prime Minister Cameron has said he will leave the decision to trigger Article 50 to the new prime minister, so we are at least a few months away from formalization of the exit. Two leaders of the movement to leave the EU, Boris Johnson and Michal Gove, have both said Article 50 does not need to be invoked immediately and may even be delayed for several years.
Once invoked, however, it will still be two years before the UK officially leaves the EU. Following the immediate shock of the vote, it is clear that Brexit is only just beginning and there won’t be any immediate changes for trade in the EU and the UK.
But in the near term, the UK and the remaining European Union countries are left with considerable political uncertainty. With Cameron set to step down, there are questions about who will be the next prime minister. The new PM will then begin the lengthy negotiations with the EU to determine what an exit will look like.
Both the EU and the UK are highly dependent on each other as trade partners but EU officials have made it clear there will be no special treatment for the UK, in large part to deter similar referendums in other EU countries. According to German Chancellor Angela Merkel, “There must be and there will be a palpable difference between those countries who want to be members of the European family and those who don’t.”
Across Europe, there are questions about other potential referendums. Scottish citizens voted overwhelmingly to stay in the EU and First Minister Nicola Sturgeon has talked about the possibility of another independence referendum. Since the June 23rd vote, there have been calls for referendums to determine EU membership in France, Italy, Holland, and Denmark. Should these countries leave, it would be more destabilizing than the UK leaving because each of these countries use the Euro as their currency. The UK never adopted the Euro, preferring to maintain the pound sterling as its currency.
Central banks around the world, including the Bank of England, European Central Bank, Bank of Japan, and the US Federal Reserve have all voiced their willingness to stimulate growth and provide liquidity to the global economy through further monetary policy. As you can see, central bank rates around the world are now expected to stay about the same or fall over the next two years. The US Federal Reserve is the only central bank expected to significantly raise rates over that time but only by 0.23%- -far different from the 1.00% per year increase the Fed was projecting coming into 2016.
FOCUS IS STILL ON THE FED IN THE US
It is difficult to predict what kind of impact, if any, Brexit will have on our economy. While growth prospects in Europe may be diminished, our trading status with the EU and the UK isn’t likely to be significantly affected. Only 13% of US GDP comes from foreign trade; it’s the actions of the Federal Reserve Bank that are more likely to have a significant impact on our economy.
On several occasions over the last two years the Fed has said it was going to raise rates, and then has failed to do so. As a result, we’ve seen counter-intuitive market turmoil: the market has gone up on disappointing economic reports and has slipped on good news, as investors anticipate the effect of the economic news on the Fed’s decisions. This phenomenon reappeared in the middle of June as the market fell just as some economic reports came in better than expected, suggesting the Fed may raise rates soon. However, the Brexit vote quickly pushed estimates of the next rate hike out as far as 2018, according to some estimates. The Fed’s Open Market Committee decided in April and again in June to delay raising rates, so the current period of historically low rates may well continue. Meanwhile, the US economy has been performing solidly. The Atlanta Federal Reserve Bank is estimating a 2.6% growth rate for GDP in the second quarter, well above the 1.1% rate seen in the first quarter.
LOOKING AHEAD
As the chart to the right shows, market shocks have been fairly common in recent years. The last four shocks prior to Brexit were all short-lived. It just goes to show that immediate reactions to news aren’t always great predictors of which direction the market is headed.
Undeniably, the landmark vote in the UK to leave the European Union creates a lot of uncertainty. Who will be the new UK prime minister to lead the exit negotiations? Will the EU make an example of the UK to the detriment of both sides? Will we look back at this vote as the beginning of the end for the European Union? Will central banks around the world push interest rates even lower? Does this really matter for global growth?
We won’t have answers to all of these questions for quite a while. We do know that the UK is still a part of the EU for a least a couple years. Over that time, however, we are likely to see additional spikes in volatility that have been more and more common in recent years even as the market has kept rising.
Ultimately, headline news tends to cause short-term market movements, but long-term market returns are driven by company earnings. Here the indications are hopeful. Earnings for S&P 500 companies have fallen for the last five quarters, even as the stock market has risen 5.3%. But earnings are projected to begin growing again in the third quarter and further accelerate in the fourth quarter as shown in the nearby chart. And in the end, earnings growth should trump even Brexit for its impact on investment returns.
SEE ALSO:
2nd Quarter 2016: First Aid Kit, Published by Benton Bragg, CFA, CFP®More About...
Equity Compensation: A Primer on Restricted Stock
Read more
Simple Solutions to Reduce Your Estate Tax
Read more
The Power of Finfluencers: Buyer Beware
Read more
Four Steps to Secure Your Digital Legacy
Read more
Fishing Requires Patience
Read more
Shedding Light on the Corporate Transparency Act
Read more