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Stocks Mixed, Bonds Rally in Q2

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Jeff-PantagesThe second quarter looked to be on track before the Brexit vote threw a monkey wrench into everything. European equity markets were hard hit, owing to the shock and future political and economic uncertainty. The US largely shrugged off the event.

Here at home the economy looks to have picked up speed with real GDP growth in Q2 expected at close to 3%, up from 1% in Q1. The unemployment rate remains low at 4.7%. The Federal Reserve will be reluctant to raise rates given global events and still low US inflation. The markets assume basically no more rate hikes this year.

For the quarter, US large stocks gained over 2%, bringing the year to date returns closer to 2 to 3%. Small and midcap stocks have done better and are up around 4% and 6% respectively, year to date. Overseas the Euro Stoxx index lost 8% in the quarter and is now down 11% year to date. Japan’s Nikkei index was down 18% year to date in local currency, but only down 4% in dollars, owing to a strong yen.

High quality bonds rallied some more pushing many markets across the globe further into negative yield territory. The US bond market must look positively mouthwatering to foreign investors. The ten year Treasury yields 1.5%. That’s down over ½% since the beginning of the year.

Commodities jumped with oil in particular settling in just under $50 a barrel. Gold has been on a tear closing at $1320, up 23% since year-end, on lots of economic and geopolitical uncertainty.

The British are leaving, the British are leaving!

Shades of Paul Revere and Americas founding: Britain has voted to leave the EU and not a shot was fired. Just as George Washington and company persevered, I suspect the British are up to the challenge, although there will be many twists and turns along the way.

Of course the markets reacted badly to the news, as it was widely assumed the Brits would stay in the EU based on “economics”. But apparently the British people were tired of their overseers in Brussels piling on mandate after mandate. They were willing to take a chance and go it on their own.

As the fifth largest economy in the world surely Britain can survive without its integration with the EU. It has two years to negotiate withdrawal and will continue to trade with EU countries, just as the US does, even after formally breaking its ties. Maybe it can join NAFTA and other free trade associations that current EU rules disallow? Perhaps by throwing off the wet blanket of EU regulations, governing everything from the required curvature of a banana or bend of a cucumber to inflexible labor laws, entrepreneurs and business will thrive.

Part of the markets reaction may have been on concern about who will be next? Will there be “copycat” referendums by other countries leading to an unraveling of the EU and ultimately the demise of the euro? Only 38% of the French have a favorable view of the EU. Frexit, anyone?

The Bank Credit Analyst thinks no other country will follow the UK out the door. In fact they view Brexit as a “political” act that may be reversed. It was a “non-binding” referendum and may be stalled by Parliament or by the calling of a new general election.  Their low-conviction view is that Brexit will ultimately be avoided, but uncertainty will reign for at least the next 3-6 months.

Thwarting the will of the people when the turnout was 72% would be deeply unsatisfactory and of course, undemocratic. This vote was in part a backlash against the elites and symbolic of a general anti-establishment mood across many countries, including the US.

The solution is to figure out ways to make free trade and globalization inclusive, not give in to protectionism. It is to encourage the Brussels bureaucracy to devolve more (not less) decision-making to individual member countries.

No crystal ball here. Time will tell.

Jeff Pantages, CFA®
SVP, Investments

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