Market Update #1 – June 24, 2016

As a follow-up to yesterday’s e-mail, the vote in the UK to determine the fate of Britain as a member of the European Union (EU) was decided in the direction of the “Leave” camp (also known as the “Brexit” voters).

This was unexpected by the financial markets.  In fact, as an indication of its optimism on the UK remaining in the EU, the Dow Jones Industrial Average added almost 400 points in just the last week.  Based on the current level of the stock market futures, all of that gain is set to be given back when the market opens at 8:30am CT¹.

Financial markets do not like surprises and tend to respond to them with tantrums and volatile behavior, at least in the short-term.

While I will check in throughout the day, I wanted to share some initial thoughts ahead of the open in US trading.

1. Why is the US market set to open weakly if this is a European issue? Financial markets and product markets are global.   Think of your favorite soft drink, candy bar or motor vehicle – likely the same brand/product is available here in the US as it is London, Berlin or Paris.  The US and Europe are trading partners and if one of the partners weakens, so does the strength of the partnership.

In addition, the US is attempting to get some traction to its economic recovery since coming out of the housing crisis and is at a delicate inflection point along that path.  Anything potentially unsteadying influences could adversely impact our growth trajectory.

2. Why would the UK vote to leave the EU if it would weaken them?  The decision to leave is likely one made with a long-term perspective and one that has been campaigned for over several decades.  The UK joined the EU over 40 years ago and certain factions within the UK have been against the affiliation as they felt that it compromised their identity, principles and economic flexibility.  While, ideally, the “Leave” camp foresees a more unified and stronger UK, it may initially put pressure on the EU in its absence.

3. How quickly will the UK secede from the EU and is there a process for doing so? “Article 50 of the Lisbon Treaty, signed in 2007 and ratified in 2009, has defined a roadmap to exit the EU. The steps are now the following:

• The UK government notifies the European Council of its intention (effectively triggering Article 50 of the Lisbon Treaty).

(Note that the UK parliament might have to approve the decision to withdraw from the EU before.)

• The European Council (without the UK) provides guidelines for negotiations with the UK;

• Negotiations between the Union and the UK can start for a maximum period of 2 years (in between EU laws will continue to apply to the UK);

• The Council needs then to obtain EU parliament consent (by a simple majority);

• The European Council finally has to accept the agreement with a “super qualified majority” (i.e. 20 out of the 27 remaining member States, comprising at least 65% of the EU27 population).

Although the Lisbon Treaty has clarified the process, what will happen from now on is far from straightforward. The referendum is indeed only an “advisory” referendum. Cameron has already explained his government would promptly trigger Article 50, but there could be a period of at least a few weeks or months before formal approval by the UK parliament.²

4. What is important to watch today in the markets? Exchanges in Europe are trading weakly this am, particularly those of the less-economically vibrant countries that can ill-afford disruption in their foreign trade – Spain and Italy are 2 examples.  So it is not unlikely that global central banks will attempt to pacify investors in these countries with the provision of liquidity to ease any stress on their banking system.  We’ll keep an eye out for that.

Also important to watch is the bond market.  Investors seek the safety of bonds when stocks are volatile which pushes up bond prices and pushes down bond yields.

Lastly, it is important to focus on quality companies and funds that are weak “in sympathy” with the broad market, tho not directly impacted by the Brexit vote.

Knee-jerk reactions are the hallmark of financial markets that are caught off-guard as they attempt to overcompensate for their lack of foresight.  Being patient, unemotional and opportunistic is where performance differences can be made.

We’ll report back throughout the day on the developments in our markets and foreign markets as well and please do not hesitate to call re: your personal investments with Kavar Capital or the markets in general.

 

¹ Source: Bloomberg Market Data

² Source: Candriam Investment Group, a New York Life Company report entitled: UK Votes for ‘Brexit’

 

 

Important Disclosures:

The views expressed herein are those of Douglas Ciocca on June 24, 2016 and are subject to change at any time based on market or other conditions, as are statements of financial market trends, which are based on current market conditions. This information is provided as a service to clients and friends of Kavar Capital Partners, LLC solely for their own use and information. The information provided is for general informational purposes only and should not be considered an individualized recommendation of any particular security, strategy or investment product, and should not be construed as, investment, legal or tax advice. Past performance does not ensure future results. Kavar Capital Partners, LLC makes no warranties with regard to the information or results obtained by its use and disclaims any liability arising out of your use of, or reliance on, the information. The information is subject to change and, although based on information that Kavar Capital Partners, LLC considers reliable, it is not guaranteed as to accuracy or completeness. This information may become outdated and we are not obligated to update any information or opinions contained herein. Articles may not necessarily reflect the investment position or the strategies of our firm.