Contributed by Doug Walters
Exit stage left
The British surprised us and the world on Thursday by voting to exit the European Union. Most indications heading into the referendum pointed towards a victory for the “Remain” campaign. Prime Minister David Cameron, who lobbied hard for the UK to remain, announced his own exit, which will take effect in October.
- Equities and the British Pound fell on Friday, while bonds rallied, with US 10-year treasury yields hitting fresh lows. As investors flocked to safety, the likelihood of a rate rise in 2016 appears to have taken a step backward.
- Stocks in the US closed down over 3%. Elsewhere, the reaction was more pronounced, with France down over 8%, Germany down nearly 7%, and Japan down 8%. Interestingly, UK stocks were only down 3%.
- The ultimate impact will depend largely on the execution of the exit and extent of the fallout throughout the rest of Europe. Will the exit be orderly? Will other countries follow suit, creating a domino effect? All of these questions point to uncertainty, which is a near-term negative for risk assets like equities.
Patience and Discipline
What happened Thursday night with the UK referendum was a truly historic event. However, the decline in US equities on Friday was far from historic. To put it in perspective, this decline, while quick, only takes US equities back to the levels of mid-May.
- Our focus remains squarely on Quality, Value and Diversification; an investment philosophy built to withstand market shocks and avoid permanent loss of capital.
- Disciplined, patient investors need not fear events like these. Stock dislocations create opportunities for active investors in the form of more attractive valuations.
|Indices & Price Returns||Week (%)||Year (%)|
|S&P 400 (Mid Cap)||-1.5||4.2|
|Russell 2000 (Small Cap)||-1.5||-0.7|
|MSCI EAFE (Developed International)||-1.8||-8.7|
|MSCI Emerging Markets||0.0||1.45|
|S&P GSCI (Commodities)||-2.0||18.5|
|MSCI U.S. REIT Index||-0.1||6.8|
|Barclays Int Govt Credit||0.2||3.0|
|Barclays US TIPS||0.3||5.6|
The United Kingdom
The British decision to leave the European Union brings focus and uncertainty to Britain’s economy. The biggest questions are how the exit will affect the country’s ability to export goods as well as services and how it will maintain its status as a global financial hub. These to be determined questions have caused the Pound to undergo an historic sell off.
The British Pound fell 7% on Friday and was down 12% from peak to trough at one point:
History in the European Union
There were 28 countries in the European Union before Britain voted to leave. Britain was late to join the European Economic Committee in 1973 as the committee was founded sixteen years prior. The EEC (renamed the EU in 1993) was created to prevent war and strengthen economic interests between member nations. The union’s core principals are:
- Freedom of movement
- Freedom of trade
- Humanitarian right protections
The ‘freedom of movement’ principal is a problem for British citizens that feel their jobs and wages are threatened by migrants from other EU members such as Poland. Another talking point for the exit camp is Britain’s £12.9bn annual EU membership dues where it only received £4.5bn back in the form of subsidies and grants. Although these dues are a small part of the government’s £760bn budget, it’s another reason to vote for Brexit.
The impacts of the UK exit decision will continue to dominate the commentary next week. Questions abound; most of which will take much more than a week to answer, such as:
- Who will replace David Cameron as Prime Minister?
- Will the Bank of England have to cut interest rates further to stave off a recession?
- Will the Fed take action to combat a strengthening dollar?
- Will there be a contagion effect across investors and risk assets?
Much has been said about the future of England’s economy, but the next focus will be on how the rest of Europe and the EU reacts.
- On Monday, EU Central Bank President Mario Draghi, Janet Yellen and Bank of England Governor Mark Carney will be discussing solutions for this and many other topics at the Forum for Central Banking.
- All eyes will be on other EU nations for signs that they will be following the UK’s lead.
On Tuesday, Strategic Holdings FactSet (FDS) and Nike (NKE) will both be reporting quarterly results.
- This will be Nike’s first report since they lowered guidance for the quarter based on department store Sports Authority going under.
- Investors will be looking for continued market share gains at FactSet
More European News
On a much lighter note for the continent, Wimbledon and Tour De France begin and the UEFA Euro Cup begins the knockout stage.
Strategic Asset Allocation
The US dollar and Japanese Yen were the big winners on Friday as the British Pound tumbled following the historic exit vote. The Pound traded down roughly 8% early Friday morning. US consumers may soon enjoy pricing discounts on their Burberry attire.
Bond. US Bond
The interest rates on government bonds pushed lower as the rest of the world looks to the US treasury market for stability. If bonds continue this momentum, the US 10 Year Treasury Note will trade below the current US inflation rate. Homebuyers continue to celebrate the low rates.
US Equities outperformed most of their international peers, with investors seeking out those stocks least impacted by the Brexit vote. With recent volatility, gold is one of the best performing commodities, providing useful uncorrelated returns.
Even Friday’s post Brexit spill didn’t trip-up the energy sector which kept some of the gains from earlier in the week. Industrials finished the week as the laggards due to outsized exposure to global growth and Europe. In other Brexit news…
- Online travel and lodging company Priceline Group Inc. (PCLN) and Expedia Inc. (EXPE) felt significant pressure on Friday as investors focused on the travel sites as big losers of the U.K. decision. One analyst defended the space by noting that the UK exit will take 2 years to complete and that the country is only 7% of the continents travel demand.
Strategic Equity Income
Utilities & Telecom company’s high dividend supported the stocks as interest rates plummeted on Friday.
- Surprisingly HSBC Bank (HSBC), domiciled in London, held in better than other Banks who were the biggest laggards this week despite positive stress test results.
- William-Sonoma Inc. (WSM) was rumored to be purchasing competitor Restoration Hardware Co. (RH). The rumored deal at $50 per share would be accretive to William-Sonoma’s earrings right away. The $50 price tag would be a huge premium to Friday’s close of $27.56, but a bargain to the $80 per share it was trading at the start of the year.
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