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In a decision that shocked the financial markets, British voters recently decided by 52% to 48% to say goodbye to the European Union in the so-called “Brexit.” It will be a long goodbye though, taking at least two years to finalize.
This uprising of the British people against the elites saw global financial markets lose more than $2.1 trillion in market value. That was the biggest single day drop in value since 2007.
The carnage was everywhere.
In Britain, 10-year gilts traded at a record low yield (1.02%) and the pound fell by 8% and at one point fell to its lowest level versus the U.S. dollar since 1985.
In Europe, stock fell sharply, with the main Stoxx 600 index falling about 7%. Germany was down 6.8%, France 8%, Spain and Italy both about 12%. The yield on the 10-year German bund fell to -0.056%. The euro fell by 2.2%.
The Japanese yen, Swiss franc and U.S. dollar soared. Gold skyrocketed by $60 an ounce. And the U.S. 10-year Treasury yield settled at 1.56%.
And of course, U.S. stock markets fell. Here’s that damage report: Dow Industrials -3.39%, S&P 500 -3.59%, and Nasdaq -4.12%.
More Fallout from Brexit?
No one knows what’s next.
Already, speculation is focusing on what European country will be next to walk away from the EU. Two names you are likely to hear are Denmark (Dexit) and the Netherlands (Nexit). Spain, Italy and even France will be talked about as possibilities. .
More countries could leave, but I have my doubts.
Bear in mind the United Kingdom – a member of the EU since 1973 – never fully integrated into the Europe. It still has its own currency – the British pound – and not the euro. It will be a longer and harder road for those countries that have adopted the euro to break away from the EU.
When looking at the financial markets, the Brexit just reinforced some existing trends in my view.
Interest rates around the world will be lower for longer. The Federal Reserve will not raise rates for a long time, if ever. And with negative interest rates the rule in Europe and Japan, the 10-year Treasury yield will continue its march toward levels not thought possible just a few years ago.
Gold and silver should continue higher too as more and more investors lose faith in central banks’ abilities to fix things.
Brexit and Currency Markets
The toughest call is on which way the various currencies will go.
On Friday, the crash in the British pound and a weakening euro sent the dollar index (DXY) soaring.
If that trend continues, it will be bad for U.S. stocks. Earnings from our multinationals will be adversely affected.
It is also bad news for most commodities, like oil, and emerging markets. A strengthening dollar will reignite talk about a devaluation of the renminbi by China. And we all remember what that did to markets to August and at the start of this year.
The Federal Reserve could stop the strengthening of the dollar and weaken it by having its officials talk in very dovish tones.
But that has its consequences too.
Japan, continental Europe and now the U.K. need weaker currencies to give their respective economies a boost. If the Fed weakens the dollar too much, those economies may tip into recession. And that again will be bad news
Some emerging and frontier markets are largely unscathed. The Shanghai index in mainland China, for example, it actually up slightly over the Friday through Monday trading sessions.
Probably the one obvious thing to do is to avoid financial stocks. Much of the selling has been concentrated there.
Just look at the carnage on Friday! Morgan Stanley – 10%, Citigroup – 9.4%, Bank of America – 7.4% and Goldman Sachs – 7%.
And in Europe, Stoxx Europe 600 Bank index plunged 14% and hit its lowest level intraday since August 2012! In the U.K., Barclays dropped 20% and Lloyds 21%. In continental Europe, Deutsche Bank and Credit Suisse both fell 14%, Spain’s Banco Santander dropped 20% and Italy’s Unicredit plunged 23%.
The combination of negative interest rates globally and a flattening of the U.S. yield curve is proving to be an unpalatable cocktail to the existing business models of the big banks.
Brexit: A Word to the Wise
I also advise readers to not listen to what the pundits on CNBC and elsewhere are saying.
They are telling you that Europe and the U.K. are doomed and to put every penny into U.S. stocks. Recall that these are the same people that never saw Brexit coming.
My inclination is to maintain a core position in the U.S. and then look to buy in those overseas markets. Europe, Japan and some emerging markets are in deep bear markets, down 20%, 30%, 40%. Valuations are dirt cheap compared to the U.S.
One fund that I like is the SPDR S&P International Consumer Staples ETF (NYSEArca: IPS). It is filled with well-known household names including Nestle SA (OTC: NSRGY), Unilever PLC (NYSE: UL), Diageo PLC (NYSE: DEO), L’Oreal (OTC: LRLCY), Reckett Benckiser (OTC: RBGLY) and AnheuserBusch InBev (NYSE: BUD).
Funds like those from Kevin O’Leary of Shark Tank fame that emphasize quality and dividends are worth a look too. These include the O’Shares FTSE Europe Quality Dividend ETF (NYSEArca: OEUR) and the O’Shares FTSE Asia Pacific Quality Dividend ETF (NYSEArca: OASI).
Slowly building positions in funds like these will turn out to be winners.
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