The U.K. vote to leave the European Union shocked financial markets, here are our thoughts:
1) The U.S. stock market is taking things in stride relative to declines globally with the U.S. market falling back to where it was just one week ago. Some of the largest declines have taken place in European stocks(-10.50%), European banks (-15%), the British Pound (-8%) and Japanese stocks (-7.7%). Fortunately these were areas of the market we have been avoiding. On the flip side Gold, U.S. Treasuries and the U.S. Dollar have all been benefactors of the vote to leave with strong gains today.
2) Britain's vote to leave was not that surprising if you looked at how close the polls were going into the vote, however global markets had strongly rallied for five straight days on the assumption the Remain vote would win. Bookmakers in the U.K. put odds at almost 80% that Remain would win going into the vote. Moving forward the U.K. will not begin to exit the EU until October and even then the process will take several years.
3) What will be interesting to watch going forward will be to see what impact, if any, this vote will have on politicians in Italy, Spain, France etc. It is possible there will be a push for similar referendums. The leading candidate in the race for Prime Minister in the Netherlands today said he will be calling for a referendum to leave the EU if he wins. The Netherlands have had five straight years of GDP growth under 1%.
On a related note, growth has continued to be abysmal in Europe. European Central Bank President Mario Draghi has repeatedly voiced frustrations that while the ECB has implemented program after program to try and boost the economy politicians have not passed pro-growth reforms. Draghi specifically has mentioned reforms in areas like labor laws, tax policy and pensions.
Sluggish economic growth was not the primary reason for Brexit. However it did play a factor and the longer politicians in other European countries go without implementing pro-growth reforms the more probable it becomes that the status quo in those countries will be upended.
4) Odds of a Federal Reserve rate hike in 2016 plummeted from 42% to 18% this morning after the Brexit vote. The awful May jobs report had taken a summer rate hike off the table. For now the odds of a hike at any time in 2016 are low. It will take much stronger U.S. economic data in the 2nd half of 2016 for a hike to occur.
The volatility that has come with Brexit is in the process of producing some attractive investment opportunities. Caution is still warranted though, as a key question to be answered will be what degree of impact this vote will have on business confidence, as one of the drawbacks of sluggish economic growth is that it leaves very little margin for shocks to the system. The U.S. economy has been able to overcome global hurdles over the past 5 -6 years and continue to plod forward with 2% GDP growth. We will be watching the data as we enter the 2nd half of 2016.