Key Points
• Britain shocked the financial community by voting to leave the European Union (EU). Global equity markets plunged as traders searched for perceived safety in the midst of uncertainty. Short-term traders should be prepared for more downside, and the risk of a global recession has risen.
• The U.S. economy is fairly healthy and should manage to stay out of recession territory in the near term, although risks have risen. Long-term investors should stay patient and disciplined.
• The Federal Reserve seems highly unlikely to raise rates in foreseeable future and further economic stimulus cannot be ruled out. Across the pond, the Bank of England has made 250 billion pounds of liquidity available, with more action possible.
Brexit shock
Britain voted to leave the EU on June 23, referred to as “Brexit.” We would term this development a market and economic shock. International developed and emerging market (EM) stocks were up through yesterday in June, and over the 90 days leading up to the referendum, suggesting they were not pricing in a Brexit outcome. The initial shock of the unexpected outcome prompted a sharp decline in stock markets around the world and we believe it may take some time for the shock to fully work through the economic, financial, and political systems in the United Kingdom and Europe. With no visible catalyst to halt the slide, the decline in global stocks may continue, as the risk of a global recession increases.
Since the end of the financial-crisis induced global recession in 2009, a series of shocks have helped to keep growth, inflation and stock market performance subdued. The shocks that have taken place in Japan, United States, and Europe may offer us some insight as to the potential duration of the market impact of Brexit.
After the shock of the devastating earthquake and related nuclear accident in Japan on March 11, 2011, the Nikkei fell 16% during the next two trading days, but fully recovered those losses by July 8—a period of four months. It is worth noting that the lingering recession caused this initial rebound to fade into two back-to-back double-digit declines and rebounds until stocks finally recovered their losses by the end of 2012.
After the congressional standoff over the U.S. debt ceiling saw the S&P 500 slide 3% on August 1, 2011, members of the House cut a deal to end it the following day, prompting U.S. stocks to have a one day rebound on August 3. But they fell another 12% over the next two months on fears of economic fallout, finally bottoming on October 3. The S&P 500 recouped these losses by the end of October, a period of three months.
Source: FactSet, U.S. Dept. of Labor. As of June 22, 2016.
The apparent tightening of the labor market, with the standard measure of unemployment now at 4.7%, is helping to boost wages. This is bolstering the U.S. consumer as the strong April retail sales report was followed by another solid report for May. Additionally, the housing market appears to be strengthening as elevated rental costs, aging Millennials, improved consumer confidence, and exceptionally low mortgage rates move more folks into home purchases.
Wages appear to strengthening
Source: FactSet, Federal Reserve Bank of Atlanta. As of June 22, 2016.
Helping to support retail sales
Source: FactSet, US Census Bureau. As of June 22, 2016.
And housing purchases
Source: FactSet, Mortgage Bankers Association. As of June 22, 2016.
The corporate side of the U.S. private sector continues to struggle to gain momentum, and manufacturing continues to flirt with contraction. The uncertainty associated with Brexit has caused the U.S. dollar to surge again and could exacerbate the manufacturing sector’s problems at least in the short-term.
Although a couple of regional manufacturing surveys inched back into expansion territory, according to the Federal Reserve industrial production fell again in May by 0.4%, while capacity utilization moved lower to 74.9 from 75.4—more than five percentage points below its longer-term average. And the continued extreme interest rate environment seems to us to be influencing corporate decision making—although likely not in the way policy makers were hoping. Stock buybacks and increased dividend payments seems to be the choice of many companies, while they remain reluctant to invest substantially in equipment and material that has longer-term potential benefits.
Fed stands ready to help
The Fed is unlikely to raise rates in the foreseeable future, and could look to add some sort of support to the economy or financial institutions if needed. Global central bankers are meeting today in a previously-schedule meeting in Basel, Switzerland. They are likely to discuss, synchronize and possibly announce short-term actions to address global financial market stresses and we will keep investors informed.
So what?
The next several weeks could be a tumultuous time in global markets, and investors need to keep a longer-term view in mind. Global stock markets have tended to ultimately rebound from other sharp declines—often fairly quickly. It can be tough to get back on track once things reverse, so we recommend investors use volatility to tactically keep allocations in line with their long-term strategic targets.
Liz Ann Sonders is senior vice president and chief investment strategist at Charles Schwab & Co.
Brad Sorensen is managing director of market and sector analysis at the Schwab Center for Financial Research.
Jeffrey Kleintop is senior vice president and chief global investment strategist at Charles Schwab & Co.