The limitations of the immediate fallout from the “Leave” vote are already taking shape in some global equity and risk markets - less than a week after the historic referendum. Despite all the angst, table pounding and rabble-rousing that defined the days leading up to and immediately following the vote, global markets have already regained much of their recently lost ground.
An effective reflection of that theme is the CBOE Volatility Index or VIX. On Thursday of last week, before the referendum results were known, it closed the session at 17.25. The following day it closed at 25.76, in the process logging a gain of 49.33%. Yesterday the VIX closed at 16.64 or 3.5% below where it closed on the previous Thursday, before the referendum. Yesterday alone it was 11.25% lower. That’s the good news for those looking for near term stability.
Now the not so good news. Other measures of investor appetite and confidence have been less comforting, less assuring. The CBOE Interest Rate 10-year yield (TNX), though having stabilized in the period outlined above continues to reflect several factors that speak to caution and risk off. On June 23rd, the yield on the 10-year closed out the session at 1.729%. On this past Monday, that yield had dropped to 1.460% or 15.5%. Given the already severely compressed yields that have manifested over the preceding 12-months (-38.92%), Monday’s 52-week low yield was worth taking serious note of, as investor prospects for inflation, growth and expansion are continuing to be reined in. As I suggested in Monday morning’s note, one of the impacts of the Brexit was the ultimate reality that the Federal Reserve would not be in a position to raise rates - possibly for the balance of the year. The TNX speaks to that and more.
The immediate fallout of the Brexit vote is now taking shape. From where I sit, several global themes are emerging that will define the landscape moving forward.
The world is not coming to end though new headwinds have clearly taken shape. Equity markets in Great Britain, Europe and the United States have managed to rebound handsomely over the past three days. In fact, US equity markets have staged their most dramatic two day rally since mid-February. Gold has lost some of its dramatic risk off glitter as the acute fear associated with the referendum has subsided.
The EU will be forced into a collective examination of conscience in regards to goal achievement for the union, methodology of achieving those goals, and a repurposing of assets to drive performance. Additionally, as I have mentioned in previous notes, nationalistic movements long simmering in the likes of France, Denmark, Belgium and others, have been provided a test case for their objectives in the UK Brexit chapter. Given the level of popular discord in EU member states, even a modicum of success in the months and years ahead by Britain will most certainly drive further fracturing in the EU.
Asia, China specifically, appears to be best positioned for any turmoil that evolves in the EU in coming months and years. China, long considered the largest risk to global financial stability suddenly finds itself on the other side of that trade. Not only does China gain by Europe’s dysfunction and marginalized efficiencies, it is no longer the poster boy for irresponsible financial market structure. The near term prospects of a China-centric free trade block in Asia will likely receive added impetus in coming months, further insulating the region from the prospect of a Europe in the throws of either near zero growth or a slow, painful reversal of fortunes - without the UK.
The US economy is also well positioned in the short run but still vulnerable to further shock waves from the EU and elsewhere as domestic economic expansion has shown signs of exhaustion. Q2 earnings season is nearly upon us and given the trend line we have witnessed in terms of corporate revenue growth (or the lack there of), modest earnings growth and highly mixed economic data over the past six quarters, any further meaningful shocks to the global economic landscape will likely accelerate our slump into a recession within the next 18 months.