Though the majority of second quarter was marked by uncertainty regarding U.S. monetary policy (the Fed), global growth, and the direction of global equity markets, it will long be remembered for Brexit – the UK’s decision to leave the European Union (EU).
Pre-Brexit, markets were largely focused on trying to determine the timing of the Fed’s next rate hike. Post-Brexit, markets were fixated on the thing they hate most, uncertainty; specifically, how Brexit might impact not just the UK and EU, but overall global growth. With no precedent to follow, in the near-term, there are likely to be many more questions than answers. As a result, markets will be susceptible to “headline risk” stemming from Brexit, resulting in periodic bouts of volatility.
Even with Brexit, second quarter was marked by a general lack of volatility as the S&P 500 traded within a very narrow range of +/- 2.9% from where it began the quarter. After experiencing 26 days during the first quarter in which it rose or fell by 1% or more from its prior day close, the S&P 500 experienced just twelve similar days in the second quarter, with half of them occurring at the end of June due to Brexit.
As a result of global uncertainty, many investors sought safety in fixed income markets, which had the effect of driving yields lower, in many cases to historic levels. According to various estimates, $8-10T of sovereign debt now yields less than 0%. Domestically, concerns about the economy resurfaced, following weak first quarter GDP growth and a marked deceleration in job growth. Some economists view slower employment gains as a sign of economic weakness. Others see it as inevitable for an economy that has added over 14 million jobs since the recession and whose current unemployment rate is well below its long-term average of 5.8%, dating back to 1950.
Internationally, growth remained a concern as China continued to show signs of slowing, Japan’s economy struggled to gain traction, and European economic growth remained muted.
Outlook– We expect the general unease that many investors currently seem to be experiencing to continue. Questions about global economic growth are likely to persist, exacerbated by the uncertainty of Brexit. While investors currently do not expect the Fed to raise rates in 2016, an acceleration in economic data, especially inflation, will likely spur questions about Fed timing. Likewise, any deceleration will likely raise fears of recession. Finally, as Brexit demonstrated, the current surge in populist, anti-establishment sentiment sweeping across the globe is both powerful and unpredictable.
As such, other unanticipated headline risks could spur increased market volatility. With so much uncertainty, we remain of the opinion that investors should prudently and opportunistically de-risk their portfolios given the limited opportunity cost…