“Surprises are foolish things. The pleasure is not
enhanced, and the inconvenience is often considerable.” (Jane Austen
1775-1817)
Digesting Surprises
To the surprise of many, Brexit materialized and
markets reacted. In short, results were historic. The element of surprise is
not pretty, especially when the stakes are much higher. Hence, Friday’s (June
24) swings and demonstrative reactions across key markets.
“The $2.08 trillion wiped off global equity
markets on Friday after Britain voted to leave the European Union was the
biggest daily loss ever, trumping the Lehman Brothers bankruptcy during the
2008 financial crisis and the Black Monday stock market crash of 1987,
according to Standard & Poor's Dow Jones Indices.” (Reuters, June 26, 2016)
Brexit is not the cause of a multi-year decline in
global growth. Rather the effect of a weak European Union, frustration over
lack of real economy vibrancy, reflection of poor Western pool leadership (on
local and global basis) and a reality check for overly-inflated markets. What
has inflated select markets can be attributed to the "disconnect"
that's been persistently in developed equity markets and
select real estate investments.
Several basic questions need to be asked about the
formation of the European Union in 1993. If European countries were in a position
of strength in the first place, why form a union? If the Economy was strong
then, why would “Brexit” be such a big deal? If the Union was so great, why did
Brexit materialize? In answering all
these questions, one must grasp the biases and agendas of this storytellers. All
that said, there is no denying that the union is weak, just like the Eurozone
economies.
Early Conclusions
The last four years have showcased three grand themes:
- The US and other nations failed to stimulate real and vibrant growth that sustains the middle class and small-mid size businesses.
- The loss of Central Bank’s creditability, who have kept rates low while failing to admit the minimal impact on stimulating economies. Now with more desperation, Central Banks will look to provide liquidity while orchestrating “crisis management”
- The lack of future faith
in globalization since the flow of goods, capital and people has not
translated to wealth creation across local economies.
One critical perspective to keep in mind: The interest
rate hike discussion in the US is looking more and more off the table,
regardless of Brexit. Perhaps, now Yellen may have found an excuse or an
"out" to claim that a rate-hike is not feasible due to the current
uncertainly. However, prior rate hikes were unjustified, the Fed’s narrative
was misleading (albeit not fully recognized), and the economic reality in being
confronted in a harsh manner has set in. Central Banks from Japan to England to
ECB are forced to adjust to current conditions, but most of this is caused by
self-inflicted wounds. The complete
dismissal of the truth by financial leaders has postponed the inevitable
correction, which is way overdue.
Days Ahead
As reactions and over-reactions are being understood
and executed, the broader question relates to market behavior over the next six
months. Digesting the news quickly is more vital than being consumed with the
theatrics of volatility and media obsession.
Exploring the Next 6 Months:
1) A US Interest Rate hike is very
unlikely in 2016.
In a world already consumed with
negative rates, that theme is not bound to change. US 10 Year Yields already
hinted at further decline months before, and bond markets are unimpressed with
US economic data. Thus, unless there is a miraculous real economy revival,
further economic weakness may trigger discussions of rate cuts rather than rate
hikes. Perhaps, that’s the surprise of all surprises ahead.
2) Volatility in public markets to
continue.
Turbulence is a function of two
issues. First, the surprise element leads to shock-like responses, which turn
into violent short-term moves. Basically, emotion-driven responses. Second, the
unknown will be even more mysterious than usual. Thus, timing the end of the turbulence
is extremely difficult, which makes more investors seek “safer” assets for
shelter.
3) Brexit can trigger new themes and
opportunities.
In the last five years, both
commodities and Emerging Markets (assets and currencies) witnessed massive
price corrections. Gold is attracting new momentum, while other commodities still
appear cheap relative to last decade prices. Meanwhile, EM themes that were in
desperate conditions may look relatively appealing as the Eurozone mess is
exposed once again. Plus, in a world of low interest rates, further risk taking
may be welcomed in less overvalued areas. From Argentina to China, bargain
hunters may seek ideas as developed markets wrestle with ongoing volatility.
Bottom-line: In the weeks ahead, the market is gearing to rotate
from digesting a surprise to grasping the new landscape. However, this rotation
may materialize much faster than the consensus expects. Capitalizing on quick
changes early might be where the big reward lies.
Article Quotes:
“China
responded to a surge in the dollar by weakening its currency fixing by the most
since the aftermath of August’s devaluation. The People’s Bank of China
set the reference rate 0.9 percent weaker at 6.6375 a dollar. A gauge of the
greenback’s strength climbed 1.8 percent on Friday, the most since 2011 as the
U.K.’s vote to exit the European Union ignited turmoil in global financial
markets. The victory for Brexit pummeled the pound and high-yielding assets as
more than $2.5 trillion was wiped from global equity values. China shared
$598 billion in trade with the EU last year, second only to the U.S., and
slowing growth and capital outflows make the nation vulnerable to the effects
of the Brexit vote, according to Bloomberg Intelligence economists
Fielding Chen and Tom Orlik. If Brexit does trigger a significant adverse
impact on European demand and global investor sentiment, China could be among
the Asian economies least well-placed to respond, they say.” (Bloomberg,
June 16, 2016)
“The UK makes up just 1.6 per cent of world oil
demand, so crude should not be too affected by a Brexit vote, many traders
think. But some analysts think the market is being blasé. The oil
market, while primarily driven long term by supply and demand, can be heavily
influenced in the short term by currency moves and traders’ risk appetite. In
the event of a Brexit the US dollar is expected to strengthen sharply, weighing
across dollar-denominated commodities as they become more expensive for holders
of other currencies. There may also be a flight to safety — in such a sell-off
oil tends to get dumped by the fast-money in favour of assets like gold. The
Greece crisis in 2012 helped trigger a near 30 per cent drop in the oil price,
albeit from a level well above its current price of $50 a barrel. Demand is
also not entirely removed from the equation. While the UK’s 64m people
consume only 1.6m barrels a day — compared to 19.6m b/d in the US, the world’s
largest oil consumer — the total EU bloc covers more than 500m people
and accounts for almost 15 per cent of global oil demand (12.5m b/d). A Brexit
is expected to be followed by greater uncertainty across the EU, probably
hampering growth in an area where oil demand was already declining for much of
the past decade.”
(Financial Times, June 23, 2016)
Key Levels: (Prices as of Close: June 24, 2016)
S&P 500 Index [2,037.41] – Failed at 2,100 in April and
again in June. In the near-term stabilization around 2,050 will be watched
closely. However, based on the recent moves in the 2+ years, a move to $1,900
appears like the next target.
Crude (Spot) [$47.64] – The commodity is trading within
a set range of $46-50 at a 50-day moving
average of $46.79, which will be tracked closely by technical observers.
Gold [$1,315.50] – A break above $1,280 marks a new, positive momentum.
Staying above $1,300 seems feasible if the shift toward safe assets continues
to emerge. Even before Brexit, stabilization was forming.
DXY – US Dollar Index [95.44] – A massive one-day move. Before
the Brexit commotion, the currency index was slightly dull in a range bound
trade.
US 10 Year Treasury Yields [1.60%] – The
break below 1.80% earlier this month showcased the weak global economy and
lower chances of a rate-hike. Meanwhile, the post-Brexit response was very
pronounced, hitting the extreme range of 1.40% at one point during Friday.
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