Tricia Leadbeater’s Market Updates

Brexit and the portfolio

June 27, 2016

Investors bet big that the UK would stay in the Union. On Thursday, the S&P 500, after several up days in a row, closed just shy of an all-time high. UK and European banks were heavily bought, along with the pound and other currencies – the Canadian dollar moved up 2%, and oil moved up 4% during the 4 days leading into the vote. Then, when the surprise outcome became known, markets reacted swiftly towards risk aversion, dumping all that they had loved in the previous week. The S&P 500 erased all of the gains it had made year to date. Equity markets were already looking fairly valued into the vote, and investors were somewhat wary of global growth prospects, so it was easy to take the opportunity to sell stocks.

Markets despise uncertainty, and is unclear how an exit from the EU will take place or what all of the implications could be, so shoot first and ask questions later was the approach. It is important to remember that Brexit is just beginning. It could take up to two years for Britain to negotiate an exit and re-negotiate trade pacts. Not only has the Prime Minister resigned, other UK leaders may be at risk, such as the Chancellor of the Exchequer and there are calls for the Bank of England governor Mark Carney to resign. As the City is the financial centre of Europe, being the central clearing-house for trading, OTC/ bond markets and currency transactions, banks were the most severely punished in markets. Many are already talking about relocating staff. From the global perspective, markets are especially worried whether this will weaken the bonds of the EU enough to prompt others to leave the union. France goes to a national election in less than a year, and far-right leader Marine Le Pen is expected to run and is already calling for exit referendum for France. There are concerns about the value of the euro, and currency traders quickly put their attention to the yen, the USD, Swiss francs on Friday.

The reaction in numbers:

  • British pound down 8% vs USD, back to 1986 levels, dropping further Monday morning

  • FTSE All World stock index down 4.8% Friday, wiping $2 trillion in market value

  • US dollar up 2.5% against all its major trading partners

  • Highest quality fixed income havens rose. 10 year government bond yields drop (prices move up): US yielding 1.5%; UK Gilt at 1.01%; German bund at minus 0.18%

  • Gold was up $75 on the immediate news, closing Friday up $53 or 4.5%

  • The domestic focused FTSE 250 down 12.3% at the open, but recovered some losses to close down 7.2%.

  • UK and European banks stood out as the biggest losers, down 18%; S&P financials in the US down 5.4%

  • Industrial metals and oil dropped on early worries about whether instability in Europe could trigger slower global demand for commodities. WTI Oil dropped 5% overnight.

  • Canadian dollar down 2% vs USD

What is important to note is that despite these dramatic sounding moves, the markets didn’t tip into panic. Investors rationally sold the most vulnerable securities: UK domestic companies, weaker regions of the EU; Financials whose businesses are heavily exposed. While the domestic British index suffered, down double-digits, the blue-chip and international focused FTSE 100 closed down only 3.2% on the day, much like the US indices. Bond-proxy, defensive equities found support. Outside the UK, Utilities and telecoms, REITs, railroads were essentially flat or barley negative on the day. We didn’t see sell-off that would precipitate margins calls and compound selling and volatility.

While a 3% one day drop is dramatic, one should note that US blue chip stocks are back to where they were only a few months ago:

One year chart on Vanguard’s Large Cap Dividend Appreciation Index Fund

Source: Morningstar

The markets are clearly more worried about the ability of Europe to overcome its challenges. Europe’s broad index, as tracked by the Vanguard FTSE Europe Index Fund is still at 2009 levels:

Source: Morningstar

Opportunities and Risks:

  • Investors should keep a long term horizon as there is likely to be a lot of short term noise, especially this week as we head into quarter-end and managers seek to rebalance portfolios quickly.

  • A further pull back in markets could provide interesting opportunities for equity investors, as prices could correct back to attractive entry levels. Broadly, there are large amounts of cash sitting on sidelines that could come back into markets.

  • The Canadian markets, with their leverage to gold companies, could continue to benefit if the uptick in the gold price solidifies. Most gold companies are strongly profitable at $1,300 per ounce gold prices.

  • We may see opportunities again in oil stocks, as the pull back in price could bring them back into attractive buying range again, assuming there aren’t shocks to aggregate demand and global growth.

  • In the short term, indebted oil and mining stocks are vulnerable again. On Friday, Glencore was down 8%; Arcelor-Mittal was down 11%; Repsol down 14%; Royal Dutch Shell down 6.5%.

  • The US dollar could continue to rise. This presents downside risk to the value of the CAD, the prices of commodities, and put downward pressure on earnings for US based international companies again. If we had a repeat scenario of USD ascendancy, global growth would be at risk. The worries that shook markets in January this year, could reverberate through the markets again.

  • It will still continue to be a benefit for Canadian investors to have exposure to the USD and US dividend paying equities, as the market will continue to look at the US economy for investment into its stable and growing economy. Investors will bid for dividend yields, liquidity and belief in the stability of the dollar.

  • The euro and the pound could continue to weaken as uncertainty over the health of the Union is increasing.

  • More government and central bank stimulus may come: The Fed is unlikely to raise rates in this environment. The Bank of England has signaled that it is ready to inject 250 billion pounds into the markets should that be stimulus be deemed necessary. The Swiss central bank intervened in currency markets Friday to attempt to push down a strong Swiss franc.

  • It will continue to be difficult to make attractive rates of return on fixed income. With rates staying extremely low, yield stocks will continue to attract investment.

  • Alternative strategies/ hedge funds that can short sell and otherwise find opportunity in volatility could benefit.

This final week of the second quarter will be interesting! If you wish to discuss this further please contact me at 403.260.8472.

Please feel free to contact me with your comments.


Tricia Leadbeater
Director, Wealth Management


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