For some time now, weak global economic fundamentals have left markets in an increasingly vulnerable position to potential policy mistakes by governments or central banks. After months of speculation, on June 23 the UK voted to leave the European Union (EU). Since then, markets have been in turmoil, and many wonder what will happen next, both in the markets and in portfolios.
Increased Volatility May Provide Opportunity
As we have seen with previous political/economic upheavals, financial markets always overreact when they are caught by surprise, so it does not pay for us to have a similar knee-jerk reaction. As the dust settles, there is going to be such tremendous volatility across all asset classes that some opportunities we have been eyeing may now be appealing and some assets we hold may present an opportunity to monetize profits.
Fed policy is likely to be more dovish
In December, the Fed announced it would begin rising interest rates. However, at its first interval, the Federal Reserve decided not to go forward. Adrian Cronje told the Atlanta Business Chronicle at the time of the decision, “Global growth is too modest to support a faster rate increase program. The Fed needs to move more slowly and monitor global growth very carefully. They do no want to disturb the current moderate growth path.” This trend is likely to continue for the rest of the year, as the Fed will now require a higher economic threshold to move forward on raising short-term interest rates. This will be supportive of precious metals and US bonds.
Ripple Effect Possible in Other EU Countries
Despite fear mongering by media and government over the consequences of exiting the EU, UK citizens told the world order that they were ready for change. While this will take time to work its way through the system, it seems likely that the government will follow the will of the people given Prime Minister Cameron’s immediate resignation.
This is likely to have collateral effect on the rest of the EU. Brexit could very well be the beginning of the domino effect leading to other countries revolting against the EU, with the most notable possibilities being Spexit, Itexit, Frexit (i.e., Spain, Italy, and France). We are monitoring credit spreads in the peripheral European countries to gauge this.
The US Is Not Immune Either
The Trump phenomenon is less about Donald Trump, himself, and more what a Donald Trump-like figure represents (i.e., citizens’ desires to uproot the old political order). Therefore, the vote to exit the EU can be seen as a major pro-Trump occurrence. This would likely be an additional bearish catalyst for US equities in the near term, as the potential for US voters to elect as president someone outside the political elite is an analogous dynamic to the UK rejecting the old guard of the EU. Whether this would be bullish or bearish in the long term remains to be seen.
Perhaps most importantly, this could signal the beginning of the structural reform we have been seeking
We highlighted in this year’s Capital Markets Forecast the importance of this and for investors to stop relying on the magic of central banks to solve their problems in both economies and financial markets. So while this may be bearish for many financial markets in the short-term because of market reaction to uncertainty, this is potentially the first step in setting up a bullish foundation for Europe in long run. As Europe reforms itself out of the zombie-like, no-growth set up that has existed since the structural European problems asserted themselves five-plus years ago, the rest of the world could follow suit as well.
We will continue to monitor the Brexit situation carefully and make modifications to portfolios to take advantage of market turbulence.