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4 Questions And Answers For Investors After Brexit

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June 28, 2016
Brexit FAQ: stock market advice for active investors.

No, it was not a dream. 

Investors woke up last week to the shocking news the United Kingdom voted to exit the European Union. While the actual nuts and bolts of Brexit will probably take years to actually complete, financial market and economic shockwaves are rumbling right now. 

Here's a look at four questions you may be asking in the wake of Brexit. 

1. Question: Could this trigger a recession in the U.S.?

Answer: The jury is still out. 

"Yes, a recession is a possibility, not necessarily a probability," says JJ Kinahan, chief market strategist at TD Ameritrade.  

Some economists are forecasting a slowdown in U.K. growth, which could lead to recession there and also spillover and possibly impact other economies in the Eurozone. Could that damage the global economy and the U.S. economy? Only time will tell. 

The key issue for U.S. companies selling abroad is the sharp increase in the value of the U.S. dollar following Brexit. In the zero-sum world of currency trading, while the British pound collapsed after the Brexit vote, the U.S. dollar gained. A stronger dollar hurts U.S. companies that want to sell their products or services abroad by making them more expensive.  

"Some are calling this a market shock. Traditionally, market shocks since World War II have been swift, but shallow mainly because they were not expected to lead to recession," says Sam Stovall, managing director at S&P Global Market Intelligence. 

This market shock is different. "There is a possibility Brexit could lead to a recession in the Eurozone. If Europe slips into recession, the deepest risk is that it drags down the rest of the world. Since economies are tethered together today, it would force the U.S. into at least a slowdown if not a recession," Stovall says. 

2. Question: What impact could this have on the stock market?

Answer: U.S. companies with an overseas presence could be hurt. 

Kinahan points to McDonald's as an example. "McDonald's has increased sales in the U.K. for 40 quarters in a row. That's at risk. With the British pound worth less, consumers have less purchasing power and this could cause people in the U.K. to hold back on spending," Kinahan explains. 

"The risk to the stock market is that a little less than 50% of revenues for S&P 500 companies come from overseas," says Stovall. 

In the short-term, stock market volatility could remain high. "It takes five trading sessions at least for news like this to work its way through the system and for markets to stabilize," Kinahan says. That means investors should be patient. "You don't have to buy the bottom or sell the top, let the market stabilize," Kinahan says. 

"I don't feel like it’s the end of the world, but I am monitoring sector performance to determine if this is a short-term buying opportunity or if it has longer deleterious effects," Stovall says. He pointed to the daily price chart as a place investors can look for clues. "If you see the S&P 500 hold up at the 2,000 level, that would be encouraging," Stovall says. 

3. Question: Where are investors turning to as a safe haven?

Answer: Treasury securities, gold, defensive sectors in the stock market. 

Many global investors rotated into the perceived safe-havens of Treasury securities and gold. "The first reaction is people sold equities and bought U.S. government securities. That is a normal reaction when there is uncertainty," Kinahan says. 

Stovall pointed to traditional safe havens within the S&P 500, the utility and telecom sectors, because of their dividend yields, and consumer staples and health care, because of their static demand. "Should the U.S. fall into a bear market, the defensive sectors tend to lose less than the overall market," Stovall says. 

Close to home? Investors looking to minimize the impact of currency exposure could consider "U.S. centric companies, which includes mid and small cap U.S. stocks," Stovall says. 

4. Question: What does this mean for the Fed?

Answer: On hold for now. 

"This absolutely puts the Fed on hold as of right now," Kinahan says. 

With the Federal funds rate barely off the zero-bound level at 0.25-0.50%, it reminds the Fed that perhaps they should have raised rates earlier, Stovall says. "With Fed funds at 0.25%-0.50% there is not really a lot of room to cut rates if they do need to stimulate the economy," Stovall warns. In the wake of the financial crisis, sluggish growth, and tepid inflation, the Fed's hands might be tied and its ability to hike rates to a historically normal level may be limited. 

TD Ameritrade clients can monitor the British pound versus the U.S. dollar (GBP/USD) in the thinkorswim trading platform. "If the pound continues to weaken, it could hurt overseas demand for U.S. products and indirectly impact earnings," Kinahan says. See the GBP/USD in figure 1.

FIGURE 1: GBP/USD REACTS TO BREXIT.

The GBP/USD fell to multi-decade lows immediately after the Brexit vote. Chart source: the TD Ameritrade thinkorswim® platform. For illustrative purposes only. Past performance does not guarantee future results.

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