“…It is clear that there would be an immediate and profound shock to our economy. The analysis produced by the Treasury today shows that a vote to leave will push our economy into a recession that would knock 3.6 percent off GDP and, over two years…”

—David Cameron and George Osborne, “Brexit Would Put Our Economy in Serious Danger”, The Telegraph, May 22, 2016

By now it is clear that the world ending predictions ahead of the Brexit vote did not materialize. Much of it was political rhetoric, disconnected from reality. Firstly, we should keep in mind that Brexit is a process that was only started by the vote, it will take some time and there might well be surprises along the way. The vote itself did trigger a selloff that was promptly reversed by central bank action, but the process of Brexit is just starting. The actual dislocation from the Brexit will be felt throughout 2016 and 2017. Theresa May, new British PM, announced that negotiations on Brexit will not even start in 2016. Secondly, there is this question. Given the situation in the global economy, should the stock market really be making historic highs against the backdrop of such shattering displays of public’s discontent, such as the Brexit vote? Let’s consider those points.

Brexit Is A Process, Not A Vote

Brexit is a process that will go on for years. Despite rebound in equities, but the negotiations could present some serious dangers along the way. Especially given the fact that Theresa May has appointed the likes of Boris Johnson, a staunch EU skeptic, to lead those negotiations. This process will not be helped by Claude Juncker, the head of the EU, who said of Brits, “I am sure that deserters will not be welcomed with open arms” and “The United Kingdom will have to accept being regarded as a third country, which won't be handled with kid gloves.” I cannot imagine Brits with their proud history succumbing to such treatment.

And sure enough Nigel Farage, the person most responsible for Brexit, announced a European ‘tour’ to stoke the flames of anti-EU referendums. So, we are in for a long game of political brinksmanship with serious effects on the economy and financial markets.

Brexit As A Catalyst?

Most astute observers point out that the real importance of Brexit is in starting the process of referendums creatively titled such as Grexit, Departugal, Italeave, Czechout, Oustria, Finish, etc. The age of global popular discontent is upon us and it is hard to imagine why investors are not discounting it in the price of equities today. And this is happening against a backdrop of weakening earnings around the world and a looming financial crisis in Europe with Italian banks leading the way and a Lehman-like Leviathan Deutsche Bank basically disintegrating. Add to that dropping Treasury yields and trillions of negative yield debt (including corporate) around the globe.

Given these facts, how is it possible that equity markets in the United States are making historic highs? Brexit vote did kick off immediate panic that led to $2 trillion of value being wiped off global asset prices. Sterling suffered the biggest one-day drop in history and U.K. real estate is projected to drop nearly 30 percent as a consequence of Brexit. But all is forgotten with more stimulus or at least hopes for it.

Buying Corporate Bonds With Public Money, While Peripheral Banks Are Failing

The political uncertainty is taking place against equally uncertain financial background in Europe. The volatility reminiscent of the 2008 crash ushered in pledges of coordinated action from central banks around the globe with ECB already buying corporate bonds in the midst of the vote. Can anyone with any sense believe it is normal for ECB to buy corporate debt? So far, ECB bought debt of about 150 companies, as this Bloomberg story indicates. A number of non-elected officials directing public money to this or that privately held enterprise, what could possibly go wrong? Surely, it is a sign of a healthy economy.

At the same time Italian and Portuguese banks are imploding right before our eyes.

Japan under Finance Minister Shinzo Abe is announcing some sort of ‘helicopter money’, an extremely aggressive spending package that amounts to handing money around far and wide in an attempt to spur the economy. He has since denied it, but it seems to be just a reaction to an uproar the news had generated. Germany is auctioning 10-year bonds at negative interest rates. We are in an economic twilight zone indeed. All stops are pulled out to prop equity markets and Brexit shock seems to be forgotten.

Are Fixed Income People Smarter Than Equity People?

But don’t be deceived by all-time highs in the S&P. Astute market participants are not buying it. Every day we hear pronouncements from top investing minds, such as Jeff Gundlach, Bill Gross or Kyle Bass, explaining that this is not going to work as intended. But those are just words; let’s look at some important metrics of underlying health of the economy and the market.

U.S. Treasury yields (10 year at 1.5 percent) are so low, that Barron’s is forced to run a story with the title “Why Are Treasury Yields So Shockingly Low?” So, both stocks and government bonds are at historic highs in the U.S., in a repudiation of every normal market relationship between the two. ‘Shockingly low’ yields are not a sign of a growing economy, quite the opposite. It is an indication of Japan style stagnation and next step, just like in Japan, is helicopter money.

Maybe Europe is doing better? No. Germany just auctioned off 10-year bonds for the first time at negative interest rates. According to Bank of America Merrill Lynch investors are holding about $512 billion of negative yielding corporate investment grade debt! And this is at a time when some of Europe’s biggest banks are on the verge of collapse.

And do not forget Deutsche Bank whose stock price lost more than 50 percent over the past year and has not really recovered with recent stock market highs. So, some investors are not buying it.

Summary

All this does not mean that a financial collapse is upon us, but it does mean that advisors must prepare investors for an increase in volatility. Violent asset move days like first post-Brexit vote days will occur again frequently and you need to prepare your clients for them. Every advisor must be watching the situation with European banks and especially Italian, Portuguese banks as well as Deutsche Bank. If DB’s credit spreads continue their ascent (they almost tripled since March 2015 to 211 bps now), the resulting volatility will affect every advisor, even if central banks manage to get equities under control again. Bonds and stocks are now disagreeing and when that happened historically, bonds have always won. Is this time different?

Daniel Satchkov is president of RiXtrema, a risk modeling and consulting firm, and creator of Advisor BioniX, the first risk-aware robo platform for advisors.