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The Brexit Vote: What You Need to Know

Posted On: Jun 27, 2016

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Today we received the unprecedented news that the United Kingdom (U.K.) has voted to leave the European Union (EU). The U.K., comprised of England, Scotland, Northern Ireland, and Wales, has been a member of the 28-nation EU since 1975. The EU members are allowed to freely move goods, capital, services, and people among the member nations. However, they do not all share a single currency. (Countries within the EU that share a single currency—the euro—are referred to collectively as the Eurozone.) The Brexit vote was a referendum on whether the U.K. would remain part of the EU or leave, and the vote was to leave. British Prime Minister David Cameron, a strong proponent of remaining in the EU, immediately resigned.

Here we break down some of the highlights and key takeaways you need to know.

Next steps. The U.K. and EU will work over about the next two years to determine the terms of the U.K.’s economic separation from the EU. Therefore, nothing happens immediately—the U.K. has just made clear that it will separate. Until then, existing trade and immigration agreements will remain in place. However, many businesses are likely to start taking actions, such as finding new suppliers, reducing staff in the U.K., cutting costs, delaying investment due to uncertainty, or making plans to move headquarters out of the U.K. We expect central banks to intervene to help stabilize markets in the coming days. Additionally, with the resignation of the Prime Minister, the U.K.’s government will need to be reconstructed before these separation conversations happen in earnest.

The vote has led to increased market volatility. Although the pre-referendum polls showed a very tight race, in the days leading up to the vote, financial markets (equities, fixed income, commodities, and currencies) had begun to expect that the U.K. would vote to remain in the EU, driving equity and commodity prices and bond yields higher. Even in the last few hours of the vote, markets were convinced that the U.K. would vote to remain. When the vote went the other way, markets responded, leaving most markets back where they were in mid-June, although some (like the British pound, European stocks, and global banks) have fallen much further during overnight trading.

Recession risks for U.K. and EU may rise. The sharp drop in the British pound, the tightening of financial conditions in the U.K., and the economic and market uncertainty around the timing and pace of the U.K.’s separation from the EU are likely to cause a slowdown, and perhaps even a recession, in the U.K. in the next few quarters. Economic growth in the Eurozone is likely to slow in response to the U.K.’s decision to leave the EU. Given how slowly the region has been growing, the decision may tip the Eurozone economy into recession.

Recession risks for U.S. still well below 50%. After the U.K. vote to leave the EU, the odds of a recession in the U.S. have moved higher, but are still well below 50%, based on our analysis of macroeconomic factors such as business and consumer spending, housing, net exports, capital investments, and government spending. Tighter financial conditions (mainly a stronger dollar) may hurt our exports and manufacturing activity, and banks and commodities sectors will be impacted, but the U.S. economy is very resilient, and the direct impact of economic conditions in the U.K. and EU may be limited.

Not another Lehman moment. While this event was unexpected, and is likely to cause some near term and perhaps even some longer lasting financial market volatility, we do not think this is another Lehman-like moment.  The U.S. economy, U.S. banking system, and U.S. consumers are in far better shape today than in 2008; just yesterday, on June 23, the Federal Reserve (Fed) released data that showed all 33 U.S. banks passed the Fed’s stress test for their ability to handle extreme, 2008-like scenarios.

We reiterate our 2016 equity market forecast. We continue to expect mid-single-digit returns for the S&P 500 in 2016,* driven by better U.S. economic growth and an earnings rebound in the second half of the year.

Fed rate hike turns into rate cut probability. Futures show a small (15%) chance of a rate cut at one of the Federal Reserve Bank (Fed) meetings over the next few months and a rate hike has been priced out by the end of 2016. This morning the Fed already announced it is monitoring markets carefully and ready to provide unlimited U.S. dollar liquidity via existing swap lines.

 

IMPORTANT DISCLOSURES

*Historically since WWII, the average annual gain on stocks has been 7-9%. Thus, our forecast is in-line with average stock market growth. We forecast a mid-single digit gain, including dividends, for U.S. stocks in 2016 as measured by the S&P 500. This gain is derived from earnings per share (EPS) for S&P 500 companies assuming mid-to-high-single-digit earnings gains, and a largely stable price-to-earnings ratio. Earnings gains are supported by our expectation of improved global economic growth and stable profit margins in 2016.

The economic forecasts set forth in the presentation may not develop as predicted.

The opinions voiced in this material are for general information only and are not intended to provide or be construed as providing specific investment advice or recommendations for any individual security. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly.

Investing in stock includes numerous specific risks including: the fluctuation of dividend, loss of principal and potential illiquidity of the investment in a falling market.

Investing in foreign and emerging markets securities involves special additional risks. These risks include, but are not limited to, currency risk, geopolitical risk, and risk associated with varying accounting standards. Investing in emerging markets may accentuate these risks.

Currency risk is a form of risk that arises from the change in price of one currency against another. Whenever investors or companies have assets or business operations across national borders, they face currency risk if their positions are not hedged.

The S&P 500 Index is a capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.

This research material has been prepared by LPL Financial LLC.

To the extent you are receiving investment advice from a separately registered independent investment advisor, please note that LPL Financial LLC is not an affiliate of and makes no representation with respect to such entity.

Not FDIC/NCUA Insured | Not Bank/Credit Union Guaranteed | May Lose Value | Not Guaranteed by any Government Agency | Not a Bank/Credit Union Deposit

Securities and Advisory services offered through LPL Financial LLC, a Registered Investment Advisor
Member FINRA/SIPC

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Brexit

Posted On: Jun 24, 2016

Today we received the unprecedented news that the United Kingdom (U.K.) has voted to leave the European Union (EU), which had led to significant volatility in the global markets. In situations like these, it becomes more important than ever to remain calm, harness our emotions, and stay committed to our long-term plans. Although this result was unexpected, we are here to offer continued support and guidance through these challenging market events.

Yesterday, June 23, the United Kingdom (the U.K., comprised of England, Scotland, Northern Ireland, and Wales) undertook an all-country referendum about whether the U.K. should stay in or exit the EU, which it has been a member of since 1975. This vote, referred to as the “Brexit” vote, is done by allowing all citizens to cast their ballot on whether to “remain” or “leave.” In a very close vote, “leave” brought in 51.9%.

In the days immediately before the vote—although it was expected to be close—the polls suggested a slight tilt that the U.K. would remain; financial markets reacted positively, with stocks around the globe rising in value, along with most foreign currencies. Early Friday morning overseas, as it became clear that, in fact, the U.K. had voted to leave, these recent gains were reversed and there have been sharp declines in global equity markets, particularly in Europe and Japan. European currencies have also weakened relative to the dollar. Essentially, the markets were expecting a “remain,” were surprised by a “leave,” and thus are reacting negatively.

Though the questions surrounding exactly how and when the U.K. extrication from the EU will happen has caused near-term financial turmoil, the actual “leave” vote does not create an immediate change in the day-to-day functioning of the markets. Rather, it’s the beginning of a process that may take two years or more to fully execute. However, in the short term, there is some additional uncertainty politically: U.K. Prime Minister David Cameron has already announced his intention to resign. There are also upcoming elections in other European countries, including Spain, this weekend. All of these just raise more questions than the markets typically like to see, which is causing this near-term turmoil.

However, as the market gets over the Brexit shock and answers start to come on other fronts, this turmoil should settle some. The global economic system is better prepared to deal with financial panics than it has been historically. Most global banks are in much better shape than they were leading up to the financial crisis in 2008, and central banks are prepared to extend credit to institutions and countries to help them manage short-term liquidity problems if they arise. 

The United States is insulated, though not immune, from events overseas. Although there has been a decline in U.S. stocks early today, it is smaller than the declines in foreign markets. The U.S. economy and the U.S. stock market are built on a foundation of domestic consumption of goods and services. Our economy is impacted by events globally, but it is not dependent on them.

In times of financial market stress, we must remember our investments are for the long term. This is a time for caution, but not panic or overreaction. Although our emotions might be telling us to act, we must resist this urge and strive to maintain a patient, long-term focus on the future. Some volatility may persist in the short term, and although we do not know for certain what lies ahead for the markets, the best course of action is to face it with a steadfast commitment to let reason, not emotion, drive our investment plan.

We are here to help you understand these very challenging times and will continue to keep you informed of all developments.

Thank you for your continued trust and confidence.

Sincerely,

Your Personal CFO Team

 

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual security. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing.

Economic forecasts set forth may not develop as predicted.

Investing in stock includes numerous specific risks including: the fluctuation of dividend, loss of principal and potential illiquidity of the investment in a falling market.

Investing in foreign and emerging markets securities involves special additional risks. These risks include, but are not limited to, currency risk, geopolitical risk, and risk associated with varying accounting standards. Investing in emerging markets may accentuate these risks.

Currency risk is a form of risk that arises from the change in price of one currency against another. Whenever investors or companies have assets or business operations across national borders, they face currency risk if their positions are not hedged.

This research material has been prepared by LPL Financial LLC.

Securities offered through LPL Financial LLC. Member FINRA/SIPC.

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Market Review Letter 06-10-2016

Posted On: Jun 10, 2016

Summer's Hot Issues

On May 21, 2015, the S&P 500 Index closed at 2,130.82, an all-time closing high for this broad measure of 500 large U.S. companies (St. Louis Federal Reserve).

In the year since, it has failed to recapture that level.

On April 20 of this year, we finished at 2,102.40 and we closed out May at 2,096.96, but there hasn’t been a new high in over a year (St. Louis Federal Reserve).

It’s not uncommon for the major indexes to go through periods where gains are elusive or we experience unwanted volatility.

According to research provided by LPL Financial Research, there have been six instances since 1984 when stocks failed to top an all-time high within a year, including the current one. During 1984, 1988, and 1995, the S&P 500 posted gains that ran from 9.9% to 18.2% in the following six months.

But shares lost ground during 2001 and 2008, as the economy was sinking into a recession.

I won’t try to predict where shares will be in six months, but most leading indicators aren’t pointing to a recession.

That leads us to the next question, “Why have the bulls seemingly been taking an extended nap?”

There are a number of reasons, but let’s hit on the major ones

  1. S&P 500 profits have declined for three straight quarters (Thomson Reuters).
  2. An earthquake in the oil industry has rippled through manufacturing, which has also hampered profits.
  3. The stronger dollar has hurt earnings of U.S. multinationals, because sales incurred overseas must be translated back into the stronger dollar.
  4. A lackluster U.S. economy is a headwind to revenue and profit growth.
  5. Lingering worries about global economic growth hamper overall sentiment.
  6. There is election year uncertainty.

 

On the flipside

  1. The earnings recession is expected to run its course during the current quarter (Thomson Reuters).
  2. Oil prices are well off the lows, which loosens the tight screws around the industry.
  3. The dollar has stabilized.
  4. Leading indicators are not pointing to a recession.

There’s not much positive to say about the global economy. As far as the election, I’ll leave that to the political pundits.

Table 1: Key Index Returns

 

MTD %

YTD %

3-year* %

Dow Jones Industrial Average

+0.1

+2.1

+5.6

NASDAQ Composite

+3.6

-1.2

+12.7

S&P 500 Index

+1.5

+2.6

+8.7

Russell 2000 Index

+2.1

+1.7

+5.5

MSCI World ex-USA**

-1.7

-1.6

-1.0

MSCI Emerging Markets**

-3.9

+1.7

-7.2

Source: Wall Street Journal, MSCI.com

MTD returns: April 29, 2016-May 31, 2016

YTD returns: December 31, 2015-May 31, 2016

*Annualized

**USD

Summertime blues: Brexit

At this juncture, let’s take a look ahead and spend some time on a couple of issues that have the potential to create short-term volatility in stocks. This won't be all-inclusive, but hits on the high points.

The first is the potential “Brexit,” the possibility that Britain will choose to exit the 28-nation European Union (E.U.) in a June 23 yes-or-no referendum.

The 28-nation E.U. is a political and economic alliance that allows member countries to benefit from free trade at the expense of ceding some political authority.

Most economists see problems in the short term for Britain if anti-E.U. forces prevail, but those same forces believe the removal of burdensome regulations would benefit the nation.

The OECD said at the top of the month that a Brexit “would trigger negative economic effects on the U.K., other European countries, and the rest of the world.”

But St. Louis Federal Reserve President James Bullard took a much more sanguine view last month, noting if the U.K. decides to leave, “the next day nothing happens” and the country will enter into departure negotiations that are bound to go “very slowly” (Bloomberg).

One potential unknown: Will London lose its status as a banking center? Or would British-based firms depart? Again, this has the potential to damage Britain’s economy.

The U.K.’s economy is much more important to Europe than Greece, and we may see added uncertainty if the election appears to be too close to call in the run-up to voting.

While a number of polls in May placed the “remain” camp in a reasonable lead, two Guardian/ICM polls at the end of last month suggested those who want to exit the EU have taken a slight lead.

Nevertheless, we all know the imperfect nature of polls, and campaigning will continue.

Whatever happens, a vote to leave would spike heightened uncertainty that could easily produce short-term volatility for U.S. stocks.

Summertime blues: the Fed

While the Fed is taking a very slow approach to raising interest rates, several Federal Reserve officials, including Fed Chief Janet Yellen, are seriously eyeing another rate hike this summer.

In remarks made in late May, Yellen noted it would be appropriate for the Fed to gradually lift the fed funds rate, with an increase “probably in the coming months (Wall Street Journal).”

Currently, odds do not favor a hike in June (CME Group), but July is definitely a possibility.

But let’s take a longer view. Historically, data from the St. Louis Federal Reserve suggests that, by itself, higher interest rates do not lead to bear markets (recessions do). But a second rate hike by the Fed has the potential to create short-term volatility for investors.

Market tailwinds

While there are short-term risks, there are also tailwinds that are supporting stocks.

Yes, corporate profits have been weak lately, but analysts are cautiously forecasting a return to growth by the third quarter (Thomson Reuters). Much will depend on the recent strength in oil prices, stability in the dollar, and continued economic growth at home.

Next, recent economic data have been encouraging. In last month's letter, I delved into some of the problems with seasonality in the quarterly GDP report. GDP, or gross domestic product, is the broadest measure of the economy. Recall that over the last 25 years, we’ve witnessed a statistically significant drag on first quarter growth (San Francisco Federal Reserve). Not surprisingly, Q2 is bouncing along at a faster pace than Q1 (Atlanta Federal Reserve).

At best, we’re seeing an encouraging though cautious acceleration in the economy. At a minimum, it strongly suggests the economy isn’t set to stall. On a more practical matter for investors, it creates a tailwind for corporate profits.

Meanwhile, even if the Fed goes through with another rate hike this summer, interest rates will remain near historic lows. Undoubtedly, low interest rates have been a challenge for savers who rely on income, but low rates are supportive of stocks when the economy is expanding.

Bottom line

You and I cannot control the stock market, interest rates, or the economy. Clearly, these variables are outside our control.

What we do control is the investment plan. So I encourage you to adhere to the one we’ve agreed upon, unless you’ve experienced a change in circumstances that means we need to adjust the plan.

When stocks are galloping ahead, some clients begin asking about a more aggressive exposure to equities.  On the flipside, when shares are down, some want to take a more conservative stance. This was especially true in 2009, when we experienced the worst economic slump since the Great Depression. It was a difficult time, and I strongly encouraged that we maintain a presence in shares. While bear markets are difficult, they are an inevitable part of the investment landscape. But always remember, storms end and rainbows follow.

I hope you’ve found this review to be educational and helpful. As I always emphasize, it is our job to assist you! If you have any questions or would like to discuss any matters, please feel free to give us a call.

Thank you very much for the trust and confidence you’ve placed in our partnership.

 Sincerely,

 Your Personal CFO Team

 

 

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.

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