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| US stock market and Brexit: a toxic blend of uncertainty and complacency | US stock market and Brexit: a toxic blend of uncertainty and complacency |
| (about 5 hours later) | |
| Welcome to Brexit bedlam. Within minutes of it becoming clear that Britons had voted to end a 43-year-old marriage to what started off as the Common Market and evolved into the European Union, virtually every financial market in the world was tumbling. The exception: currency and debt markets outside Europe, as investors sought refuge in US Treasurys and other “safe haven” securities. | |
| By midday Friday, major US market indexes had tumbled between 3% to nearly 4%, causing some $675bn in market value to simply go up in smoke and erasing all this year’s hard earned gains. | By midday Friday, major US market indexes had tumbled between 3% to nearly 4%, causing some $675bn in market value to simply go up in smoke and erasing all this year’s hard earned gains. |
| You can blame the reaction in the United States on a toxic blend of the worst enemies of market stability everywhere: uncertainty and complacency. | You can blame the reaction in the United States on a toxic blend of the worst enemies of market stability everywhere: uncertainty and complacency. |
| To be sure, the prospect of the United Kingdom leaving the European Union has real consequences both for a number of US companies and for the global economy, and thus for the earnings power of the Standard & Poor’s 500-stock index. But that’s a long-term scenario: nothing will change tomorrow, next month, or even this year that would justify the magnitude of the market’s response. The British pound plunged to levels not seen since 1985; gold posted one of its fastest rallies ever recorded, soaring 22%. | To be sure, the prospect of the United Kingdom leaving the European Union has real consequences both for a number of US companies and for the global economy, and thus for the earnings power of the Standard & Poor’s 500-stock index. But that’s a long-term scenario: nothing will change tomorrow, next month, or even this year that would justify the magnitude of the market’s response. The British pound plunged to levels not seen since 1985; gold posted one of its fastest rallies ever recorded, soaring 22%. |
| Related: A pyrrhic victory? Boris Johnson wakes up to the costs of Brexit | Related: A pyrrhic victory? Boris Johnson wakes up to the costs of Brexit |
| What European traders described as panic selling was orderly but intensive selling pressure in the stock market in the US – and all because investors had become complacent that the Remain voters would prevail at the polls. Two-thirds of the fund managers surveyed by the Bank of America Merrill Lynch in early June said they viewed Brexit as being “unlikely” or “not at all likely”. It’s that view, and not a Brexit scenario, that had been priced into the market. | What European traders described as panic selling was orderly but intensive selling pressure in the stock market in the US – and all because investors had become complacent that the Remain voters would prevail at the polls. Two-thirds of the fund managers surveyed by the Bank of America Merrill Lynch in early June said they viewed Brexit as being “unlikely” or “not at all likely”. It’s that view, and not a Brexit scenario, that had been priced into the market. |
| And now we are left with the second deeply loathed market phenomenon: a set of unknown risks, in the context of a big market selloff. And this time, the nature of those risks and that selloff are unprecedented. We’re in uncharted territory, and the unknowns are multiplying like rabbits. | And now we are left with the second deeply loathed market phenomenon: a set of unknown risks, in the context of a big market selloff. And this time, the nature of those risks and that selloff are unprecedented. We’re in uncharted territory, and the unknowns are multiplying like rabbits. |
| “Anyone who tells you where the S&P is going to bottom or isn’t really going to bottom isn’t really being honest,” argued Scott Wren, senior global equity strategist at Wells Fargo Investment Institute, during a conference call to discuss the post-Brexit investment climate on Friday. That doesn’t mean he’s predicting calamity, however; he, at least, views the vote and the subsequent turbulence as posing “a speed bump, not a brick wall” to US equity markets. | “Anyone who tells you where the S&P is going to bottom or isn’t really going to bottom isn’t really being honest,” argued Scott Wren, senior global equity strategist at Wells Fargo Investment Institute, during a conference call to discuss the post-Brexit investment climate on Friday. That doesn’t mean he’s predicting calamity, however; he, at least, views the vote and the subsequent turbulence as posing “a speed bump, not a brick wall” to US equity markets. |
| But in a market with new sources of risk, and lots of unknown elements, being complacent that stocks will soon get back on track and start recovering some of their lost ground is perilous. | But in a market with new sources of risk, and lots of unknown elements, being complacent that stocks will soon get back on track and start recovering some of their lost ground is perilous. |
| Thursday’s vote marked the beginning of a long and complicated process that will culminate in the final separation of Britain from the EU, likely years from now. In the meantime, we’ll learn whether Europe takes a hard line in negotiations, which could make markets significantly more volatile in the short term, but also dampen the risk that other separatist groups draw encouragement from Brexit and begin clamoring for separation from an existing nation-state and/or from the European Union. | Thursday’s vote marked the beginning of a long and complicated process that will culminate in the final separation of Britain from the EU, likely years from now. In the meantime, we’ll learn whether Europe takes a hard line in negotiations, which could make markets significantly more volatile in the short term, but also dampen the risk that other separatist groups draw encouragement from Brexit and begin clamoring for separation from an existing nation-state and/or from the European Union. |
| Related: EU referendum morning briefing - sign up here | Related: EU referendum morning briefing - sign up here |
| It’s not impossible that this marks the beginning of a period of political and economic chaos in Europe. That, in turn, may damage an already fragile global economy and hamper the earnings outlook for US companies. | It’s not impossible that this marks the beginning of a period of political and economic chaos in Europe. That, in turn, may damage an already fragile global economy and hamper the earnings outlook for US companies. |
| “For now, I’m characterizing this as a shock rather than a Lehman Brothers-like event that precipitates a major collapse,” says Jeff Kleintop, chief global investment strategist at Schwab. But the risks have risen, and Kleintop notes that many investors already have decided to linger on the sidelines, reluctant to venture into the market. “Volatility has been our word of the year already, with markets going nowhere except up and down.” | “For now, I’m characterizing this as a shock rather than a Lehman Brothers-like event that precipitates a major collapse,” says Jeff Kleintop, chief global investment strategist at Schwab. But the risks have risen, and Kleintop notes that many investors already have decided to linger on the sidelines, reluctant to venture into the market. “Volatility has been our word of the year already, with markets going nowhere except up and down.” |
| Kleintop also views the Brexit vote as a notable sign of another trend that adds a new source of risk to the investment landscape. Once, it was up to central bankers at the Federal Reserve, the Bank of England, the European Central Bank and other such institutions, to shape the path of economic growth. | Kleintop also views the Brexit vote as a notable sign of another trend that adds a new source of risk to the investment landscape. Once, it was up to central bankers at the Federal Reserve, the Bank of England, the European Central Bank and other such institutions, to shape the path of economic growth. |
| “Now we’re moving to a post-central bank world where that role belongs to politicians,” he says. “The central bankers have run out of tools.” | “Now we’re moving to a post-central bank world where that role belongs to politicians,” he says. “The central bankers have run out of tools.” |
| Hal Scott, professor of international financial systems at Harvard Law School, and a director of the Committee on Capital Markets Regulation, argues that an unintended consequence of the reforms passed in the wake of 2008 financial crisis has been to cripple US central bankers should the market turmoil end up becoming another market catastrophe. | Hal Scott, professor of international financial systems at Harvard Law School, and a director of the Committee on Capital Markets Regulation, argues that an unintended consequence of the reforms passed in the wake of 2008 financial crisis has been to cripple US central bankers should the market turmoil end up becoming another market catastrophe. |
| “We have dodged a bullet so far, but a financial panic might still be in our future and the US government has fewer tools to deal with it” than before the Dodd-Frank reforms were implemented, Scott argues. He adds that the Fed would require approval from the secretary of the treasury to lend to any non-bank institution, even if it means saving the financial system from collapse. Similarly, the Fed faces limits to its ability to respond to a run on money market funds or provide insurance on all forms of accounts. | |
| He’s dismayed that the Fed hasn’t followed the lead of European central bankers to commit to doing whatever is needed to ensure that markets remain orderly. “I’d like to see Jack Lew [Treasury secretary] come out and say, ‘whatever the Fed needs, I will back.’ This is a big contingency here, since nobody really knows what could happen going forward.” | He’s dismayed that the Fed hasn’t followed the lead of European central bankers to commit to doing whatever is needed to ensure that markets remain orderly. “I’d like to see Jack Lew [Treasury secretary] come out and say, ‘whatever the Fed needs, I will back.’ This is a big contingency here, since nobody really knows what could happen going forward.” |
| Friday’s market move was merely the first move in what is going to be a very long and complex game of chess. En route to the final showdown – negotiating the terms of Britain’s divorce settlement – many of the moves are going to have the potential to destabilize global financial markets, and we won’t know which ones they are until they hit the headlines. | Friday’s market move was merely the first move in what is going to be a very long and complex game of chess. En route to the final showdown – negotiating the terms of Britain’s divorce settlement – many of the moves are going to have the potential to destabilize global financial markets, and we won’t know which ones they are until they hit the headlines. |
| So treat the Brexit bedlam as a reminder to avoid parochial complacency, at all costs. Just because an event takes place thousands of miles away, there’s no guarantee it’s not going to have an impact on your portfolio. After all, the ostrich sticking his head in the sand remains visible, and vulnerable, to everything heading his way, even if he can’t see it coming. | So treat the Brexit bedlam as a reminder to avoid parochial complacency, at all costs. Just because an event takes place thousands of miles away, there’s no guarantee it’s not going to have an impact on your portfolio. After all, the ostrich sticking his head in the sand remains visible, and vulnerable, to everything heading his way, even if he can’t see it coming. |