A contrarian’s take on Brexit market turmoil
It has been a terrible start to the week to say the least as market participants had the weekend to digest the results of Thursday’s Brexit vote.
Not helping matters is all of the headline reporting that has been relentless with their doom and gloom forecasts. There is talk of banks and other financial companies relocating their headquarters, pundits predicting that this will lead to the breakup of the entire EU, forecasts of a disastrous recession that will spread from the U.K. into other European nations, and even those calling this the next “Lehman moment” that will result in 2008 part deux.
Given all of this negative press coverage, it really isn’t surprising to see investors react by hitting the sell button first and asking questions later.
In particular, the Briti sh sterling has t aken a pounding, excuse the pun, collapsing back to 1985 levels against the U. S. dollar. Global equities have also reacted selling off anywhere from five per cent to 10 per cent since Thursday’s vote and investors have flooded into U. S. dollar assets sendi ng t he dollar i ndex up nearly four per cent, and the 30- year U. S. treasury yield to a record low 2.3 per cent.
Consequently, commodities denominated in U. S. dollars are down three per cent while oil prices have collapsed 6.5 per cent. Despite this, the Canadian equity market has fared well with the S& P TSX falling only three per cent.
Looking ahead, while there will no doubt be some weakness in European and potentially even global markets, the contrarian in us has us seeing opportunities amongst all of the selling.
A key take- away that we t hink many are missing is that global markets are still fully functioning, backstopped by very active central banks who will continue to provide a tremendous amount of liquidity — something that wasn’t done in early-2008 as the mortgage crisis began to unfold.
That said, logic and reason often get thrown out with the bathwater during tumultuous times so it is important to take a breather and consider what real potential outcomes will come from last week’s vote.
For example, think about the implications for the U. S. Federal Reserve. There is no way that they are going to increase interest rates in the foreseeable future given what has just happened.
The U. S. dollar has rocketed halfway back to its beginning of the year highs, leaving little room if any for a hike. In our view, the high dollar will once again provide a clear and present danger to U. S. corporate profitability and overall economic activity while other countries continue to benefit from their flat to negative rate policies and depreciat- ing currencies.
A rising dollar is also not good for commodities, and especially oil prices. But on the positive, a dovish Fed could provide tremendous support looking forward. On the fundamentals side, we just don’t see how demand for oil will be negatively impacted by last Thursday’s decision and lower oil prices will only continue to put pressure on the current oversupply situation.
Here in Canada, a weaker commodity market could re- sult in further action being taken by the Bank of Canada in the form of another rate cut. This would be great news for sectors like real estate, oil and gas, and manufacturing who will all benefit from a lower Canadian dollar.
Looking to Europe, we expect further uncertainty and likely more weakness ahead at least until the implications of the Brexit are fully understood and implemented.
Fr o m an i nvestment standpoint, the expanded volatility is creating much better premiums which is a good thing for those of us who are active in the option market. Specifically, we are seeing some excellent opportunities to add tax- efficient income with some downside protection from option writing strategies.
Finally, for those with more of a traditional buy and hold philosophy, be sure to ask your manager what specifically they are doing to manage the risk in this current environment. Look for allocation adjustments and other strategies that will not only provide some downside protection but also position accordingly for the eventual recovery.
A DOVISH FED COULD PROVIDE TREMENDOUS SUPPORT.