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Brexit on the corner

Brouwer & JanachowskiJune 17, 2016

Markets have that tired feeling. The S&P 500, European and UK markets dipped mid week and then recovered. The UK market, still the world’s fourth largest, was off by 4% at one point. It is now down 4% for the year. The Brexit vote has scared people. Rightly so. The economic reasons for staying are powerful yet nuanced. The emotional reasons to leave are visceral and blunt. It could go either way, which is not what we would have thought a few months ago. Elsewhere, these caught our attention

  1. Federal Reserve: a two-day meeting resulted in no change in rates. There’s a bit of a ritual to this Fed.
  • Talk up the economy from one meeting
  • Mention how growth and labor are doing well….
  • But that inflation is low because [insert reason of choice]
  • Postpone growth and normalization 6 months
  • Send out regional Fed governors to contradict the statement
  • Repeat

The market doesn't believe the Fed. Take a look at this chart, which shows what happened to the Ten-Year Treasury this week:Blog june 17 201610 Year 2_TRYUS10Y-FDS (2)

The mid week drop down to 1.52% was the lowest since November 2012. No one really expects any change in rates until the Fall and one prominent Governor, and persistent hawk, expects only one hike in the next few years. You can see it here on the infamous dot plots but those are much discounted these days. So, on we go. Low rates. Low growth.

  1. Negative rates: we have written about this before, but here's the visual:blog june 17 2016 All yield curves_TRYUS-FDS (2)

The line across the middle is zero. Below that and all bonds are locked into a guaranteed loss. Central banks are trying everything to lower yields and boost spending. It’s not going to work. People do not have confidence. At best, it makes cash itself attractive. If you have a €100 or ¥10,000 bill, it makes more sense to keep it stashed under the bed than to keep it in a bank. There’s no penalty and it retains its value.

Investors have made a killing on government bonds this year. But it’s mostly down to low inflation, lots of dovish talk and recommitments to policy. Recently, the Brexit fears meant another flight to quality, which benefits Treasuries. We don't see an immediate end to any of this. Except Brexit. The vote is next Thursday. The “remains” are at 43% compared to 45% last week.  The “leave” group is at 48% compared to 42% last week. If “leave” it goes, things will get ugly.

Bottom Line: Stocks are trading in a narrow band at the 2000-2100 level. We’re fine with that. It gives us time to consolidate and get through the summer months. Confidence is thin right now, despite an uptick in M&A activity. Mind you, the Microsoft purchase of LinkedIn looks pretty desperate on both sides. Stay tuned.

blog june 17 2016 spxfib2_SP621-SPX (2)

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--Christian Thwaites, Brouwer & Janachowski, LLC

 

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