Since the rebound from the first quarter oil-related sell-off, the S&P 500 was trading in a range between 2,040 and 2,119. As oil prices moved towards $50/barrel, all eyes turned to the United Kingdom (UK) and its referendum on remaining in the European Union (EU). Despite the dire warnings about leaving, the UK voters elected to cut ties.
Markets hate surprises and uncertainty and the Brexit, as it has been named, brought both. The “yes” vote surprised investors, triggering a global sell-off. The S&P 500 and UK’s FTSE both lost about 5%, while Japan’s Nikei shed 8%. Markets will regain the lost ground, but it could take some time as investors sort through the uncertainty of a country exiting the EU for the first time. The unprecedented process could take up to two years as a massive number of agreements will need to be renegotiated or initiated--things like trade, movement of labor, and airspace just to name a few. Needless to say, the disruption of these negotiations will weigh on an already fragile EU and global recovery. The consensus is a negative economic impact on both the UK and the EU.
The European woes will wash ashore in the U.S. Our concerns begin with a stronger dollar. With the uncertainty in Europe, the U.S. dollar and Japanese yen will continue to strengthen as foreign investors flee to safety. The stronger dollar will create downward pressure on the price of oil and on U.S. companies’ profits overseas. A weakening economy in Europe and the UK will also dampen corporate profits.
Fortunately, unlike last year, oil is in a better place to weather this pressure. Saudi Arabia reported inventories have declined six straight months while they have pumped out oil at near-record levels. For now, we see oil continuing to trade in a range, somewhere between $40 to $55 per barrel. Relatively low and stable oil prices will help tremendously.
The U.S. economy continues to move forward unevenly. Business optimism remains low while the U.S. consumer confidence increased to mid-March levels. A strengthening EU recovery would have helped. Now U.S. economic growth depends more on the U.S. consumer. April retail sales were up, so that’s a good sign. Housing continues to provide good news--existing home sales and new home sales increased. Unemployment remains stable. However, only 38,000 jobs were added in April. Economic growth prospects were already adjusted downward before the Brexit. Undoubtedly, the Brexit will knock GDP down a few more tenths of a percent, edging towards 2%.
Expect greater volatility going forward as the negotiation process produces uncertainty. However, we believe the good news will outweigh the bad news and the market will climb higher through the volatility. Bonds could rally in the short term as interest rates will stay lower for longer as the world digests the economic news. We are committed to an overweight in domestic equities and an emphasis on quality, dividend-paying stocks.
As always, please contact us if you would like to discuss your accounts.