If you want to have better performance than the crowd, you must do things differently than the crowd. – Sir John Templeton
Fears that voters in the United Kingdom would choose to exit the European Union became a reality last week and the shocking result caused global stock market averages to fall. What looked like a positive week for the S&P 500 Index with a gain of 2% through Thursday unraveled on Friday as the index lost almost 4% after news of the Brexit vote. European stocks fared even worse as investors came to grips with the realization that there will be much uncertainty with regard to the details and timetable of an eventual withdrawal from the EU by Great Britain. If there is one thing that markets abhor, it is uncertainty and fear of the unknown. Confident that the “remain” camp would be victorious leading up to the vote, stock markets around the globe had rallied but the rally quickly reversed itself after the outcome of the vote was learned. There was an immediate flight to safety as stocks sold off with the price of gold rising and yields on bonds plummeting. The yield on the 10-year Treasury fell to 1.58% and the price of gold soared to $1,322 an ounce. In the weeks and months ahead, Britain’s historic “leave” vote will have both immediate and long-term consequences for the global economy and financial markets. In testimony before Congress last week prior to the Brexit vote, Federal Reserve Chair Janet Yellen warned that a vote by the United Kingdom to exit the European Union could have “significant economic repercussions”. She also emphasized that such a result could pose risks to financial stability, especially in light of sluggish economic growth, low inflation and global monetary policies that are already very accommodative. The Fed will likely maintain its cautious approach with regard to interest rates and despite the negative implications for global growth as a result of the “leave vote”, the U.S. economy should continue to grow modestly and avert a recession. The same cannot be said for Europe, whose economy has struggled to grow and which now faces another headwind in the form of an uncertain future for the United Kingdom and the European Union.
In economic news last week, data on the housing sector was mixed. Existing home sales rose 1.8% in May and reached a 9-year high, suggesting that the housing market remains on solid footing. New home sales, on the other hand, declined from the previous month. Durable goods orders were also weaker than expected in May as defense aircraft orders fell sharply. Weekly jobless claims dropped 18,000 to 259,000, well-below expectations and near a 43-year low. Not since 1973 have weekly jobless claims held below 300,000 for this long, nearly 70 straight weeks.
Although Fed Chair Janet Yellen was optimistic about overall U.S. economic growth, she cited several reasons to be cautious about her outlook. These included the disappointing May jobs report, weak business investment, low productivity and the challenges that China faces in transitioning from export-led growth to a more consumer-driven economy.
For the week, the Dow Jones Industrial Average lost 1.6% to close at 17,400 while the S&P 500 Index also fell 1.6% to close at 2,037. The Nasdaq Composite Index declined 2% to close at 4,707.
The final estimate for first quarter gross domestic product (GDP) is expected to be only 0.8%, although most economists believe that second quarter GDP growth has accelerated to about 2.5%. Both the June Chicago purchasing managers index (PMI) and the ISM manufacturing PMI are expected to be slightly above 50, indicative of continued expansion. Construction spending in May is also forecast to rebound and increase slightly after posting a decline in April.
In the aftermath of the Brexit vote to leave the European Union, Fed Chair Janet Yellen and ECB President Mario Draghi will address a European forum on central banking. The Federal Reserve will also release results from its stress tests on banks that will determine whether banks can increase their dividend payouts and stock buybacks.
The most familiar blue chip companies scheduled to report earnings this week include Nike, General Mills, Monsanto, Micron Technology, Con Agra Foods, Darden Restaurants and McCormick & Co.
The vote in the United Kingdom to leave the European Union will have implications for Great Britain as well as the rest of Europe and the global economy. Growth in the UK will likely be lower and inflation higher and the Bank of England may be forced to cut interest rates to stimulate growth. Britain has a two-year time frame to execute its exit and trade agreements with the European Union and the U.S. will have to be renegotiated, which could add to the uncertainty and adversely affect trade and investment spending. The United Kingdom has the fifth largest economy in the world but contributes less than 4% to the world’s total GDP so its overall impact on the global economy is relatively small. A bigger concern is the possibility that other member countries in the European Union become emboldened by the Brexit vote and contemplate withdrawal. While the odds of a recession in the UK have increased as a result of the Brexit vote, the risk of an outright recession in the euro zone is still quite low. The uncertainty over the future of the UK and the rest of Europe will contribute to lower consumer and investor confidence, but this should not undermine recent improvement in the European economy. As far as the U. S. is concerned, strength in the dollar will help companies that buy goods from abroad but will hurt companies that export their products to the UK and Europe. The Federal Reserve will likely leave interest rates unchanged at their July meeting and may not raise rates at all for the rest of the year. The fallout from the Brexit vote on the U.S. economy will likely be minimal as our exports to Great Britain comprise less than 1% of U.S. gross domestic product. The uncertainty caused by this historic vote will undoubtedly lead to greater near-term volatility in the markets while the longer-term financial, economic and political effects are impossible to predict at this point. For investors, the best approach in situations like this is to review your investment objective, current asset allocation and tolerance for risk and make sure that you are comfortable with all three. After panic selling and overreacting subside and markets become more rational and less emotional, volatility can present opportunity and markets tend to bounce back.