The day before the UK voted to leave the European Union, the S&P 500 closed at 2113. Last Friday, it closed just under 2103, less than 0.5 percent lower. Even more surprising, through trading on Monday of this week, the FTSE 100 index of UK equities is actually higher by almost 3 percent than it was before the vote. The EuroStoxx 50 index has fared worse by comparison, having fallen 5.8 percent, but it had been down by 11 percent in the days immediately after the vote. This modest selling pressure has led some to conclude that fears of Brexit were overdone and that life will simply go on as before the vote. But such complacency may be a mistake. Brexit is not a financial crisis, nor a Lehman type moment. But it is a political shock that will likely have significant economic implications, particularly in the UK and the EU, which will become apparent only over time. The muted reaction expressed in the movement of the broader indices cited above may not tell the whole story. First, the relative strength in stocks has mostly been attributed to the promise by central banks to provide sufficient liquidity to prevent conditions from deteriorating. But that faith in the power of monetary policy seems to overlook its diminishing effectiveness. Central bankers themselves have expressed the view that monetary policy is reaching its limits. And investors have reacted poorly to the spread of negative interest rates. The thinking seems to be that a deluge of liquidity has not done the job so far, so let's try even more. Maybe more liquidity can help in the short-run, but not in the long-run. Structural reforms are needed now. Second, a look inside the broader averages shows that the landscape has, indeed, changed since the vote took place. Although the S&P 500 has declined by just 0.5 percent, only the defensive utilities, consumer staples, and healthcare sectors have outperformed. Utilities are higher by 4.3 percent. In contrast, financials are lower by 2.5 percent, including banks which are lower by 6.3 percent, as the ensuing flight to safety has driven bond yields to record lows and global growth forecasts have been lowered. Materials are down 3.7 percent, as the dollar has firmed. And while the FTSE 100 may be higher today than before the vote, that is only in local currency terms. However, since the vote the pound has plunged 11 percent versus the dollar, turning that 2.9 percent gain into a 7.6 percent loss. Measured in euros the loss is 5.9 percent. And when measured in dollars the 5.8 percent decline in the EuroStoxx 50 index expands to 7.5 percent. Hardly a non-event. Other assets exhibit the same concern. Since the vote, gold is higher by 7.3 percent. The yen has firmed. The yield on the ten-year Treasury note is lower by 31 basis points at 1.44 percent, and briefly touched its all-time low last week. Longer maturity bonds are trading at all-time low yields. German ten-year yields have dropped 23 basis points to -0.14 percent. And expectations for the next Fed rate hike have been pushed out to 2018. The operative word in the aftermath of Brexit is uncertainty. The terms of separation will not be known for some time as negotiations will linger for years. That uncertainty will translate into economic stagnation as investment decisions are put on hold. The impact will be felt most acutely in the UK and secondarily throughout the EU. In contrast, the US will be relatively less impacted, but it will not be immune. Maybe in time Brexit will turn out to have been a good decision for the UK. But in the months immediately ahead its economy is certainly likely to struggle. Evidence of that should begin to emerge in the July data scheduled for release in August. Closer to home, the much awaited June jobs report is scheduled for release on Friday. The consensus forecast is calling for a big rebound to 175,000 new non-farm jobs from the sluggish 38,000 in the May report. If that doesn't happen, then our own economic outlook will begin to be questioned, since the consumer sector has been its primary support.
Important Disclosures: The S&P 500 is an index containing the stocks of 500 large-cap corporations, most of which are American. The index is the most notable of the many indices owned and maintained by Standard & Poor's, a division of McGraw-Hill. The FTSE 100 is a market-weighted index of the 100 leading companies traded in Great Britain on the London Stock Exchange.
The EURO STOXX 50 is a market capitalization-weighted stock index of 50 large, blue-chip European companies operating within eurozone nations. The universe for selection is found within the 18 Dow Jones EURO STOXX Supersector indexes, from which members are ranked by size and placed on a selection list.
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