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Carnage in the Market: Brexit Vote Smacks Stocks, But Long Process Ahead

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June 24, 2016

(Friday Pre-Market) Brexit won and the markets appear to have lost.

Early Friday, after Britain astonished the world with its vote to leave the European Union, global markets fell sharply, and the U.S. wasn’t immune. U.S. stock futures fell as much as 5% overnight, and 10-year bond yields tumbled to as low as 1.4%, close to record lows as investors sought safety.

Though the overnight carnage in U.S. futures has been dramatic, keep in mind that futures markets often overshoot. Cooler heads may prevail after the first 15-20 minutes of the normal trading day. That’s not to say that markets won’t be down, but some of the sharpest losses overnight may have been somewhat exaggerated.

Another thing to keep in mind is this: Britain voted to leave the E.U., but it doesn’t happen immediately. It isn’t as if the vote happened today and they’ll be out of the E.U. on Monday. First, the governing party has to appoint a new prime minister to replace David Cameron, who resigned after the vote. That could take a few months, perhaps until October. Then Britain starts the negotiation process that will determine its future trading status with the E.U., and that could take two years. The upside (or downside) of this drawn-out procedure is that the markets get to talk about Brexit for about two and a quarter more years!

Across the markets, what is Brexit’s immediate impact?

·       The dollar is up sharply against the euro and the pound, rising to its highest level against the pound since 1985. Strength in the dollar often means weakness in commodities, and oil futures fell 5% early Friday.

·       U.S. Treasury bonds skyrocketed, with yields falling to near record lows in what appears to be a safety play by investors looking for a secure place for their money. As a result, 10-year yields fell to near their 2012 record lows.

·       U.S. financial stocks could be in for a very tough ride due to those falling bond yields. That’s the first area where the market may take a major hit.

·       European stocks have been smacked and could continue to see pressure. Early Friday,  Germany's Dax index fell as much as 10 percent before paring losses, London's FTSE was recently down 4.5 percent after reducing losses and the French CAC fell around 8.5 percent.

It’s still early hours, so the full market impact of this historic vote has yet to be seen. Some analysts are saying Europe could fall back into a recession due to Brexit, but time will tell. Obviously, economic weakness in such a huge market could translate into weakness here in the U.S. as well. If the economy weakens, there would be less pressure on the Fed to hike rates.

S&P 500

FIGURE 1: BEFORE BREXIT, MARKET MOVED HIGHER.

The S&P 500 (SPX), plotted through Thursday on the TD Ameritrade thinkorswim platform, rose to nearly its highest level of the year ahead of Brexit, but Friday could be a different story. Data source: Standard & Poor’s. For illustrative purposes only. Past performance does not guarantee future results.

Economic Data Fail to Impress: Amid all the Brexit excitement, U.S. new home sales and leading indicators data for May both came out Thursday, and neither impressed. Both data points were coming off a strong April, so perhaps some fall-off might have been expected, but Thursday’s numbers failed to meet even lowered expectations, with leading indicators falling 0.2% compared with consensus for a 0.2% increase, and new home sales coming in at a seasonally adjusted annual rate of 551,000, compared with consensus for 560,000, according to Briefing.com. Since the disappointing May employment report, economic data has been a mixed bag, with retail sales and existing home sales looking strong but now some weaker numbers on leading indicators and new homes, though it’s fair to point out that new home sales remained well above the year-ago level. Friday morning’s durable goods data could provide the next insight into economic health.

Did They Turn On Those Rigs Yet? U.S. crude producers put new rigs into production over the last few weeks, reversing a long downward trend, according to Baker Hughes. But production hasn’t ticked up as a result, at least not yet. U.S. daily oil production fell to 8.677 million barrels during the week of June 17, the Energy Information Administration (EIA) reported Wednesday, the lowest level since September 2014, and down nearly 1 million barrels a day from the same week a year ago. New production can typically take some time to get started, but recent prices around $50 a barrel may have some producers in a more optimistic mode. Some analysts believe low capital expenditures recently by producers worldwide could continue to provide a bullish spin for oil prices in coming months. Friday afternoon’s weekly Baker Hughes data could provide an updated look into U.S. producers’ plans.

Crude and Natural Gas Go Their Own Ways: Normally, the crude oil and natural gas markets move pretty much together, but this week there’s been an unusual divergence. While crude oil keeps flirting with the $50 level despite a lower than expected U.S. supply draw, natural gas has fallen from recent 10-month highs due to rising inventory numbers. Though from a historical sense, natural gas remains pretty cheap at around $2.68 per million British thermal units, it’s well above the 17-year lows below $2 that it recorded earlier this year. Warm summer weather forecasts helped along the recent rally.

Good Trading,
JJ
@TDAJJKinahan

Want More on the Markets?

Join us at 4:15 p.m. ET today for a webcast featuring TD Ameritrade experts JJ Kinahan and Craig Laffman. They'll be discussing how Brexit is impacting markets across the globe, and what could be ahead. 

JJ Kinahan

JJ began his career in 1985 as a Chicago Board Options Exchange...

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