Financial markets round the world slumped Friday, blindsided by the previous day’s stunning Brexit vote. The major U.S. stock indexes fell nearly 4% Friday and finished down over 1% on the week, after having been up 2% just before Thursday’s referendum.
The U.K. decision to leave the European Union isn’t good for U.S. equity market sentiment in general, with investors already jittery about U.S. and global growth, and trade. Brexit has heightened fears about both the free flow of capital and nationalism. Even the perception that capital may not be able to move freely is an “undeniable negative” for financial markets, says Jeff Bahl, principal at Bahl & Gaynor.
The vote also means the Federal Reserve will most likely hold off raising interest rates. A July hike—already doubtful—is probably off the table. Brexit’s effect on Standard & Poor’s 500 index earnings-per-share growth might not be significant, but it doesn’t help an already-weak picture.
The Dow Jones Industrial Average fell 1.6% or 274 points to 17,400.75, and the S&P 500 gave up 34 points to 2037.41. The Nasdaq Composite dropped 2%, to 4707.98. On Friday, the Stoxx Europe 600 index fell 7%, and stocks fell about 6% globally.
Brexit is a reminder, says Kate Warne, an investment strategist at Edward Jones, that “you don’t invest based on polls,” a particularly relevant observation ahead of the U.S. presidential elections.
In terms of implications, the exit will probably take a few years to unfold, and is more specific to the U.K. than the rest of the world. It could cause delays in economic decisions by businesses and consumers in the U.K. and possibly elsewhere, but not a global recession, she says.
The keys to whether the U.S. economy is affected significantly will be whether equities tumble enough to have a major impact on business and consumer confidence, and whether banks are so affected that they pull back on lending, according to a report from Jim O’Sullivan, chief U.S. economist at High Frequency Economics. U.S. exports to the U.K. make up about 0.7% of U.S. gross domestic product.
Brian Belski, chief investment strategist at BMO Capital Markets, says Brexit will favor North American financial stocks over European ones. Indeed, the European bank stock sector, which has had a poor year, plunged 14% Friday to its lowest level since August 2012.
THE MARKET’S BIG SLIDE Friday after the surprise Brexit vote was one more example of the failure of the S&P 500 to surpass its all-time high of 2130.82 over the past 13 months, after brushing up against it several times. Bulls point to a lack of participation by individual investors in this seven-year bull market—compared with the great tech bull of 2000—as a positive contrarian sign. Once the market gets by this rough patch, they will pile in and drive prices higher.
Some sentiment indicators, however, show individual investors are already close to being fully invested. U.S. households’ equity holdings at the end of March equaled 51.5% of their total financial assets, according to Ned Davis Research Group. That’s significantly above the mean of 44.4% since 1952, says Davis, the company’s senior investment strategist and founder.
Moreover, household cash allocation was 25%, lower than the 32% mean. So, investors have less dry powder than they do on average. Allocations are close to levels in the past when the market was overbought, he adds: “When investors are pretty fully invested in stocks, the returns looking out 10 years are generally poor.” There is a strong correlation between household asset-allocation levels and long-term equity returns, according to NDR research. Other data show institutional investors and foreigners are fully invested, too, he observes. That leaves corporate share buybacks as the biggest source of stock market impetus. In fact, Davis says, the main reason stocks have done so well and could have further upside is that corporations continue to be huge buyers. Nevertheless, if they are purchasing their stock at overvalued levels and the market falls, or if they are using lots of debt for repurchases and interest rates go up, it’s a negative for the company and its shareholders.
Corporate buybacks, along with negative real interest rates in the U.S., could yet push the market higher, Davis says, adding that he remains “mildly bullish.” However, he views the upside as limited because the market apparently is in a mature phase.
(Source: Barrons Online)