“The British Are Leaving… The British Are Leaving!”
In late June, news that the United Kingdom has voted in favor of leaving the European Union dominated the headlines. We believe “Brexit” is a minor event for U.S. stocks, but is consequential for bond investors.
It is important to note that the vote does very little to alter the relationship between the U.K and greater Europe until the Westminster government invokes Article 50 of the EU charter. This begins an up to two-year process to negotiate its new position with the continent. Both sides share an interest in maintaining robust trade ties. Until the new relationship has been negotiated, the uncertainty will put pressure on European financial institutions and increase demand for safe haven assets such as U.S. Treasuries.
Notably, the major international stock indices that plummeted after the vote have regained most or all of their pre-Brexit levels. To us that means investors still face a fairly valued U.S. market and mildly better values in Europe and Japan.
At the close of the week following “Brexit”, the 10 Year U.S. Treasury bond yielded just 1.46%, just a bit above an all-time low, as bonds staged a furious rally. The German 10 Year Bund traded at a yield of an extraordinary minus 0.13%. While bonds may sell off a bit from an overbought position, we believe yields will stay low for the next several quarters. The Fed is likely to postpone its next rate hike until later this year or even 2017.
With the focus on the “Brexit,” the issues that confront China have moved off the front page. It is increasingly likely that moves to be undertaken by Chinese authorities will stimulate demand, particularly for basic commodity inputs like copper, a positive for those markets. The U.S. economy seems to be on firm ground particularly in employment and housing. U.S. profits may improve a bit from their decline of the past few quarters. Global growth seems set to continue the positive but anemic path it has followed in recent years.
Attention will be focused in the coming weeks on the foreign exchange markets as unusual strength in the dollar will affect the profits of U.S. multinationals. Also it will be important to watch the spread between the yields on government bonds and riskier corporate bonds as rapidly widening between these two instruments can indicate impending turbulence in financial markets.
While it is challenging to remain optimistic amid the current news flow and uninspiring politics, we think cautious optimism is justified. We continue to counsel a substantially invested position with just a small nod to caution in the form of extra cash.
The Altavista Investment Team - Summer 2016