PMC Weekly Review - June 17, 2016
Global markets were treated to a return of volatility this week. The proximate cause was the stark realization that the upcoming June 23 referendum in Great Britain over whether to remain in the European Union might actually produce a victory for the “Leave” vote. Until very recently, betting markets and investor wisdom saw little chance of that outcome, until a slew of polls showed that the vote might not only be close, but also might actually lead to a fracturing of Europe’s tenuous economic and political balance.
The result was a sell-off in equities, a spike in the volatility index as measured by the VIX (often referred to as the fear index or the fear gauge), and a flood of money pouring into A-rated sovereign bonds, such as Germany and the United States. That action pushed yields lower: into negative territory for German bunds and Japanese bonds; down to 1% for UK bonds; and towards 1.6% for U.S. 10-year Treasuries. The trend to low, low rates was then confirmed by the Federal Reserve’s Federal Open Market Committee (FOMC) meeting this week. Rather than raising the short-term lending rate to 50 bps as had been widely expected only a few months ago, the Fed and its Chairwoman Janet Yellen held rates steady, and signaled that the pace of future increases would be slow indeed, with perhaps only one more increase this year. Although the possibility of a “Brexit” was one factor, so too was the slowing curve of U.S. job growth, along with still modest evidence of strong wage growth.
In tandem with expectations for yet another quarter of falling earnings for the S&P 500, these developments firmly checked what had been some decent momentum propelling global and U.S. equities, as well as bond yields, higher. It’s certainly true that markets did not enter anything resembling panic: we had no sell-offs equivalent to what we witnessed at the beginning of 2016. Sentiment in that sense is guarded, but not yet relentlessly negative, although bank stocks did decline more steeply in anticipation of the negatives associated with a possible rupture of the EU.
The Brexit referendum, however, is simply another one of the market risks, which are neither common nor as uncommon as many would like. Traders can and must position for market reactions, but most investors should not, given that in this case, the long-term consequences could cut several different ways, and may not have a simple and quantifiable impact. The larger context is that we remain firmly entrenched in a low-yield, low-return environment, and there is little indication that it will change anytime soon.
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