MARKET COMMENTARY

Crossroads Ahead: Brexit, Rates, Elections

06.03.2016 - Ronald Sanchez

Over the next few months, policymakers and voters will make decisions that could have profound and far-reaching implications for investors. They include Britain's future in the European Union, changes to US interest rates and the election of a new US president. In our view, the uncertainty surrounding these decisions is bound to cause confusion and volatility.

What Happens if Britain Leaves the European Union?

On June 23rd voters in the UK will decide whether Britain stays in the European Union (EU) or exits, an event the media is calling Brexit.

The referendum could affect investors who participate in global markets, which includes all of us to one degree or another, either directly or indirectly.

A decision to leave would likely ripple through the British economy, shaking international trade relations, immigration policies, financial regulations and national security. It could also affect the political landscape in Europe and become a point of contention among US presidential candidates.

The binary nature of the vote's eventual outcome is notable. A vote to stay maintains the status quo, the possibility of a relief rally notwithstanding. But a 'no' vote could have wide-ranging ramifications, depending largely on how Britain plans to structure its relationship with the EU if it is no longer a member.

A vote to leave would likely result in market volatility and could push Britain into a recession.

A departure could also have a domino effect, encouraging populist movements in other countries and leading to a fragmented Europe. Almost 28% of the portfolio managers surveyed by MSCI recently said a departure would lead to "a handful" of other countries following suit. Nationalist agendas have already gained steam in Scotland, Catalonia and other regions that are leaning toward independence.

Market behavior shows that investors are watching these developments with some apprehension. In England, for example, rapidly-changing voter sentiment has led to volatility for the British pound.

On May 31st, the research firm Strategas reported that only 7% of the 650 institutional investors the firm surveyed thought Britain would exit the EU. In the end, we also suspect Britons will favor the economic security of membership in the EU over demands for sovereignty. A vote to stay would likely be favorable for the markets.

What Happens when Rates Rise?

In the US, the Federal Open Market Committee is scheduled to convene on June 14th to reconsider its historically low policy rate and release its Summary of Economic Projections, followed by an eagerly-awaited press conference. The probability of another rate hike has risen during the past six weeks, but a quick return to a "normal" interest rate environment does not seem to be in the offing.

The minutes from the Fed's April meeting made it clear that the possibility of a rate hike in June was suddenly back on the table for discussion. Until then, the market had been playing down the probability of tightening, which jumped from low single digits to roughly 26%, according to CME Group, a prominent player in the futures trading business.

Unfortunately, while record-low yields have frustrated investors, we don't expect the Fed's slow and gradual rate hikes to offer meaningful interest rate relief any time soon.

When rates do start rising again, we can expect bond prices to fall (they are inversely correlated). In general, bonds with longer maturities are more sensitive to interest rate movements than shorter-term bonds. We generally focus on short-term and intermediate-term bonds.

Which Candidate Would Be Better for Investors?

This year's presidential campaign in the US has also added to the confusion and volatility.

CEOs who are struggling to understand what might actually change under a new administration are faced instead with anti-business rhetoric and blustery talk of protectionism. These theatrics have only served to aggravate the uncertainty that has constrained retail spending among consumers and capital expenditures among CEOs.

The spectacle of this election cycle has also exposed a growing sense of frustration on both ends of the political spectrum. Hence we see a market that is being swayed not only by economic and financial data but also by investor sentiment.

All of this uncertainty weighs on financial markets.

The million-dollar question is: Which candidate would be better for investors? The research firm Strategas published an article in March that concluded Hillary Clinton would benefit hospitals, HMOs, solar and renewable energy companies, infrastructure, private equity and manufacturers. A Trump administration would support defense and cyber security companies, multinationals with large foreign cash holdings, the consumer discretionary sector, infrastructure, financials and companies facing competitive pressure from China.

The questions about whether or not Britain will leave the European Union, the impact of possible rate increases and which presidential candidate will be better for markets will be answered before the end of the year, providing investors with more clarity. Only time will tell if the answers to these questions boost investor confidence.

 


This communication is intended solely to provide general information. The information and opinions stated are as of June 3, 2016, and may change without notice. The information and opinions do not represent a complete analysis of every material fact regarding any market, industry, sector or security. Statements of fact have been obtained from sources deemed reliable, but no representation is made as to their completeness or accuracy. The opinions expressed are not intended as individual investment, tax or estate planning advice or as a recommendation of any particular security, strategy or investment product. Please consult your personal advisor to determine whether this information may be appropriate for you. This information is provided solely for insight into our general management philosophy and process. Historical performance does not guarantee future results and results may differ over future time periods.

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