Implications of Brexit!

   Schwaben Blog

June 30, 2016

 

Monthly Statistics:

  Today Month Ago Year Ago
  30-June-16 30-May-16 30-June-15
       
S&P TSX 14,100 14,226 14,743
S&P 500 2,093 2,099 2,079
DJIA 17,800 17,807 17,766
OIL $48.50 $48.70  $62.66
USD vs CAD 0.7742 0.7742 0.8303
Gold $1,324 $1,246  $1,172

 

So far the year 2016 has had no shortage of major events and one event that will go down in the history books is Brexit, short for exit of Britain from the European Union. The markets and the oddsmakers were caught off guard by the U.K.’s historic vote to leave the European Union on June 23. The shocking news sent ripples across the global economy and sent the pound down to its lowest level in 31 years. The equity markets across North America were also down sharply.  After Brexit, Scotland and Northern Ireland, afraid of being left out of Europe, are also preparing for a referendum to leave the UK and stay in the European union. That referendum has already gathered more than 3 million signatures. Whether Scotland and Northern Ireland will stay with the UK or not is still undecided, but the most important outcome of Brexit is that the business investment across the Europe will be dampened due to the heightened uncertainty of the implications of Brexit. London’s image as the financial hub of the world is in danger now as major investment banks and financial institutions are looking to cut jobs there and are planning to set up new branches in Dublin, Luxembourg and Frankfurt to have continued access to the EU nations.

While this is a major event in global economy, it is still unlikely to seriously hurt the US and the global economy.  According to Factset, UK is the third largest generator of revenue for the S&P 500 among the US trading partners, but it’s still pretty small. Sales from the UK make up just 2.9% of the overall revenue of the S&P 500. On the global level, the UK accounts for only 3.6% of global imports of merchandize goods and 4.1% of global imports of commercial services, so even if there is a recession in the UK (which is highly likely), the direct effect on global GDP should be minimal.

When markets are awash with fear and uncertainty, investors tend to run towards the safe haven, usually Gold or US treasuries. This flight for safety pushed the US treasuries almost to the lowest level in four years and strengthened the US dollar against major currencies.  A further strengthening of the dollar in response to global risk aversion would be a problem not only for U.S. growth prospects but also for all the dollar debtors in emerging markets, and could also push commodity prices lower. Also, roughly half of S&P 500 revenues are from other countries and any further appreciation in the USD would dampen the prospects of near term growth in the index’ EPS. At this juncture, the US economy might be strong enough to tolerate the normalization of monetary policy but the global economy is much more vulnerable to the Fed’s moves. After the outcome of the the Brexit referendum a rate hike in July is completely off the table and with the US presidential race in full swing, a September rate hike has very low probability as well. Central bankers across the globe also vowed to take further steps to limit any economic fallout. With additional stimulus expected from Bank of England, Bank of Japan, and European Central Bank, any interest rate hike by the US Fed would send the dollar through the Stratosphere.

 

 

 

 

Source- Bloomberg, Globe Investor, Financial Post, Market Watch, FactSet, Trading Economics

 

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Is the US Economy Ready for Another Rate Hike?

   Schwaben Blog

June 06, 2016

 

Monthly Statistics:

  Today Month Ago Year Ago
  06-June-16 06-May-16 06-June-15
       
S&P TSX 14,226 13,690 14,743
S&P 500 2,099 2,046 2,079
DJIA 17,807 17,632 17,766
OIL $48.70 $42.68  $62.66
USD vs CAD 0.7742 0.7728 0.8303
Gold $1,246 $1,266  $1,172

 

During the latest Federal Open Market Committee (FOMC) meeting, some of the Fed governors discussed about the possibility of a rate hike in June. The FOMC is keen to further increase the interest rates because they believe that the US economy is showing more signs of sustainable growth with inflation hovering around their 2% target. The unemployment rate has also dropped to 4.7% (lowest in eight years) in May from 5% in April. But this drop in unemployment rate was primarily a result of people dropping out of labor force rather than finding new jobs. 458,000 people dropped out of labor force, either because they don’t want to work or they don’t think that they can land a job. Employers added only 38,000 jobs in the month of May, lowest monthly growth since September 2010.  The unemployment rate is calculated by comparing the number of people who are out of work and looking against the total number in the labor force. If someone is out of the labor force, he isn’t counted.  The dismal unemployment report in May will certainly push back the Fed’s plan for a rate hike soon. According to the CME Fed watch tool, there is only 4% probability of a rate hike during the FOMC meeting in June, compared with 31% in July and 44% in September.

At this juncture, the US economy might be strong enough to tolerate the normalization of monetary policy but the global economy is much more vulnerable to the Fed’s moves. The tightening of the US monetary policy and the liberal monetary policy in Europe and Japan have certainly contributed to the strength of USD and weakness in Euro and Yen. The recent weakness in Euro and Yen hasn’t had a very noticeable effect on the Europe’s and Japan’s exports, but the strength of USD certainly had a negative effect on the earnings of US corporations. Roughly half of S&P 500 revenues comes from abroad and any further appreciation in the USD will dampen the prospects of near term growth in the index EPS. For Q1 2016, 72% of the companies have reported earnings above the mean estimate and 53% have reported sales above mean estimate. The earnings declined by 6.7% on a year-over-year basis. This marks the first time the index has seen four consecutive quarters of year-over-year declines in earnings since Q4 2008. Profits for the S&P 500 also declined by 8.3% (2.9%, if excluding the Energy sector).  Now that the oil prices have recovered by more than 70% from their February lows, the majority of equity analysts believe in a brighter outlook for the index and recommend an average increase of around 6% in the S&P 500 EPS over the next 12 months, with growth in all sectors but Energy. With additional stimulus expected from the European Central Bank (ECB) and the Bank of Japan (BoJ), a rate hike by the Fed will push the USD toward record highs and this will hurt the profitability of US corporations.