July 2016 | www.selectasset.com
July 2016 Market Update
Aftershocks from the UK’s surprise vote to “Brexit” (leave the EU) on June 23, were felt around the world. U.S. stocks plunged sharply on June 24 with the Dow Jones average down 611 points, or more than 3.4%. Banks and oil companies were hit particularly hard. The U.S. Federal Reserve announced the same day that “it was monitoring developments in global financial markets, in cooperation with other central banks, and was prepared to provide liquidity, as necessary.” By the end of trading on June 27, the “carnage” continued, but economists were also predicting that Brexit would be just another in of a series of “headwinds” that have contributed to “sluggish growth,” according to the Wall Street Journal. Initially, Brexit is expected to result in a stronger U.S. dollar, which would make it more difficult for U.S. companies exporting to foreign markets, such as the EU. In light of market forecasts just before Brexit, the pessimism among traders is not surprising. On June 22, the International Monetary Fund (IMF) downgraded its forecast for the U.S.A. by predicting growth of only 2.2% in 2016 as opposed to its previous forecast of 2.4% in April. However, IMF managing director Christine Lagarde said “the U.S. economy is in good shape.” The University of Michigan’s “Index of Consumer Sentiment” for June, released the day of Brexit, slid slightly to 93.5, down from its 94.7 figure in May. This suggests that U.S. consumers are expecting a slower pace of economic growth, but not a recession, in the year ahead. In some areas, such as the market for existing homes, sales increased in May to reach their highest level since February 2007. On the other hand, in the same period, orders for durable factory goods dropped 2.2%, more than the expected 0.5% drop. The decline was largely due to a huge 34% drop in defense aircraft orders. By the end of June the stock market bounced back enough to regain pre-Brexit levels, but people were still pumping money into 20-year corporate and 30-year U.S. Treasury bonds in a search for security. All reports indicate that the Federal Reserve Board is not likely to raise interests rates in the foreseeable future.
Going into the June 23 Brexit referendum, most economic analysts in the UK and around the world were forecasting a mixed but still upbeat outlook for the UK economy, assuming the nation voted to remain in the EU. Then the unexpected happened, and financial markets reacted immediately. On Friday, June 24, the British pound experienced a record one-day dive to a 31-year low, and it dropped further the following Monday. Britain’s big banks were hit particularly hard. Chancellor of the Exchequer George Osborne reassured markets and the public that this was not a repeat of the 2008 financial crisis, but spokespeople for leading business groups and individual corporations warned they might move some of their operations to the EU. It was reported that HSBC, the largest bank based in the UK, might move 1,000 personnel to Paris. On June 24, the Financial Times reported UK GDP growth forecasts from five highly respected sources. All showed steady growth over the next five to 15 years despite Brexit, but most predicted lower growth than if the UK remained in the EU. For now, speculation is focusing on the short term. Goldman Sachs warned that the UK was likely to enter a recession within a year. Moody’s, the rating firm, said Britain “is not looking at a recession.” Despite the damage on Friday and Monday, markets started to bounce back on Tuesday, June 28 and the following day. Pharmaceuticals were the first to recover followed by the Financial Times Stock Exchange (FTSE) 100 index. At the close of Wednesday, the FTSE 100 reportedly recovered all of its loses, but not all analysts were convinced the recovery was solid. With so many political issues in flux, such as who will be the next prime minster now that David Cameron resigned, many experts are at a loss to predict what Brexit will mean in the short to mid term. Will the U.K. be able to negotiate an exit agreement that minimizes damage to both the UK and the EU? Only time will tell.
Following the shocking news of the Brexit vote on June 23, European markets reacted as might be expected; they all dropped with two days of panic-like trading. Recovery began on Wednesday, June 28, even though Jean-Claude Trichet, a former president of the European Central Bank, called the vote "an earthquake." With governments ready to provide liquidity if needed, financial markets continued to recover through the end of the month. Major indexes, led by the FTSE 100, FTSE 250, and DAX index, were all up. But there are still signs that many investors are fleeing to safer markets. The global bond market has been very active, driving yields to new lows. For example, 30-year U.S. Treasury bonds, were approaching their all-time low of 2.223% on June 30. In some cases, including the German 10-year Bund, yields were a negative 0.13% on June 29. But analysts feel investors cannot drive bond yields much lower because the global bond market is already carrying about USD 11.7 trillion in negative-yielding debt. Heightened uncertainty over the economy is also helping to keep the European Central Bank in easing mode. In a side issue that was not received much press, if Britain leaves the EU, eight other EU member states, which have not adopted the euro, will also feel increasingly “orphaned,” according to the Wall Street Journal. Meanwhile, in the auto industry, Volkswagen AG announced on June 28 that it had reached settlement agreements with government and private plaintiffs in the USA regarding approximately 475,000 diesel engine vehicles. The massive settlements, if approved by regulators, could cost VW as much as USD 10.033 billion.
In Japan, the Brexit vote announcement caused a sharp drop (7.9%) in stock prices on the Tokyo Stock Exchange on June 24, with the Nikkei suffering its biggest one-day drop in 16 years. The yen also jumped about 5% against the U.S. dollar. But unlike other markets, Tokyo recouped some of that loss by Monday, June 27 when it finished up 2.4%. Perhaps of far more concern to the Japanese government was a rush by global investors buying yen and government bonds. The yen, regarded as a relative “safe haven,” climbed as high as 99.0 to the U.S. dollar on Friday. By Monday, however, with the government warning that it might need to intervene, the rate of exchange for the yen returned to near 102 to the dollar, and finished at around 102.6 on Thursday, June 30. Yields on government bonds, on the other hand, slid to record lows. By the end of the month, overnight buying sent the yield on 20-year Japanese government bonds to a record low of 0.39%. Prime Minister Shinzo Abe pledged on Wednesday to use every policy means available to keep the economy rolling, which means more monetary stimulus. Meeting with the Bank of Japan for the second time since the UK vote, Abe reiterated the need to provide liquidity to prevent any market squeeze. The Abe government still feels it might be forced to intervene to weaken the yen, even though such a move carries serious risks. The Japanese economy expanded at the fastest pace in a year during the first quarter, but low consumer sentiment, slow wage gains, the drag from depressed emerging markets, and now the added pressure on the yen, have only further clouded prospects for the year. With Abenomics under increasing criticism, it may be important to remember that the NIKKEI 225 Index lost 4729 points or 23.26% during the last 12 months.