Weatherhelm Capital Management
June 29, 2016
“Brexit” by the Numbers
On June 23, the British people undertook an historic vote to leave the European Union. This political lightning bolt has sent global financial markets reeling. To put this move in context, we thought it would be useful for our clients to have a look at Brexit by the Numbers.
- GBP/USD Pound Sterling 6/24/16 intraday High: 1.5019
- GBP/USD Pound Sterling 6/24/16 intraday Low: 1.3216
June 24 was the most volatile day ever in “Cable” (the nickname for the GBP/USD currency cross rate, after the submarine cable over which it has traded since 1866). This dramatic move illustrates how wrong the markets had the outcome of the Brexit vote. In the days leading up to the referendum, UK odds makers had the percentage chance of the Remain camp winning at over 90%. On the day of the referendum itself, one of the leaders of the Leave movement conceded defeat early in the evening only to find out his side had won hours later! The point is that the markets had this dead wrong, and the volatility of the last couple days is due more to wrong-footed positions rather than actual market impact in our view.
- Total loss in global stock market capitalization since 6/24: $2.8 Trillion
- Great Britain’s Percentage of Global GDP: 2.36%
While we remain only a few percentage points away from the all time highs in U.S. stock markets, global markets have been much harder hit. The total loss in global market capitalization from this event was much larger than the actual footprint of the UK. The buzzword of the week is “uncertainty.” Markets “do not like uncertainty” and that is why they have fallen so steeply. We are much more concerned with the bigger macroeconomic picture than knee-jerk reactions and believe that indiscriminate selling across the board has created opportunities in sectors which should not be directly impacted by the Brexit vote.
- Total Gross U.S. International Trade (2015): $3.748 Trillion
- Percentage of U.S. Trade with Great Britain (2015): 3.1%
What is the impact to us here in the United States if the UK leaves the EU? While our international banking sector may be affected, the overall impact to the U.S. economy will be small. The risk is one of contagion, but our sense is that our financial system is on much stronger footing than we were years ago and that the U.S. economy will weather this storm largely unaffected. The U.S. market remains the nicest house on the global stock block.
Our concern these days is more based on falling corporate earnings and the overall valuation of the market. The S&P 500 has now had 5 consecutive quarters of declining earnings, the first such “earnings recession” since 2008-09. The forward P/E ratio of the S&P is now 15.8 while the 10 year average is 14.3. We have had elevated cash levels and index put option hedges in many of our client accounts based on these concerns.
- Implied Probability of a December Interest Rate Increase: 11.8%
- Move in the U.S. Dollar index YTD / Since 6/24: -0.78% / +2.71%
One of the takeaways from the last couple of days is that the Federal Reserve will not increase interest rates. The Fed is certainly on hold until after the election and probably for the remainder of the year. Typically this movement would be bearish for the U.S. Dollar against other currencies, which in turn would give a lift to stocks. Perversely, we have witnessed a strong rally in the Greenback in this flight-to-quality, risk-off market: the 10yr U.S. Treasury Yield has declined to 1.43%, just shy of the 20 year low of 1.38%.
The direction of the U.S. Dollar is the key metric on our radar screen at the moment, if the dollar can stabilize and resume its downward trajectory, we will become more bullish on stocks, particularly the interest rate sensitive sectors such as REITs and those stocks with exposure to rising metals and commodity prices. If the dollar continues to rise, further caution in stocks is warranted as corporate earnings will be impacted further.
At times like these, the Weatherhelm approach differentiates itself from our competitors as our option hedging strategies, cash and bond positions can help buffer against portfolio declines. Please keep your ears open for those friends and family that may not have fared so well lately or are expressing concerns. We would love to talk, and meanwhile we shall remain –
Steady at the helm,
J. Clark Kastner
Managing Director, CIO
Weatherhelm Capital Management