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Investors and Bond Markets on Edge Ahead Of Brexit Vote

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June 14, 2016
Investors and Bond Markets on Edge Ahead Of Brexit Vote

Volatility alert. Investors have been skittish rotating into traditional safe-haven assets such as government debt and also into gold. Just nine days ahead of the U.K's vote on whether to remain in the European Union, dubbed "Brexit," some investors are bracing for the potential of a disruption. 

A new poll released last Friday by ORB International revealed the Leave vote ahead at 53% to 47%.

Yields Fall to Record Lows as Bond Prices Rise

Government bond yields in Japan, Germany, and the U.K. hit new record lows last Friday, as investors bought safe-haven investments. The 10-year German bund hit a record low Tuesday, falling below 0.0% to a negative yield.. The yield on the 10-year Japanese government bond touched a low of negative 0.152%, while the 10-year U.K. gilt yielded 1.215%, also a new low.

Importantly, bond prices and yields share an inverse relationship. For example, if investors are buying bonds, prices rise and yields fall.

"People are worried. They are buying bonds as a safe haven," says Sam Stovall, managing director at S&P Global Market Intelligence. Stovall highlights two critical factors that tend to rattle stock market investors: the potential for recession and uncertainty.

Right now markets are staring at both straight in the face.

"Bull markets don't die of old age. They die of being scared to death that their country or the globe is headed for recession," Stovall says. The current earnings recession in U.S. stocks has been an omnipresent black cloud for the bull market. "Since World War II, we've had 13 earnings recessions and 11 of them preceded economic recessions," Stovall says.

A Leave vote on June 23 could be a potential trigger for recession in the U.K. and Eurozone, with potential ramifications around the globe as well, some economists say.

 "Investors are worried Britain will vote to the leave the EU which would cause the pound to decline sharply. It would force the country to renegotiate its trade agreements with EU and non EU partners. Forty-four percent of British exports go to the EU, which is a meaningful amount," Stovall says.

Two Moves Investors Might Study Now

Tighten your safety belt, Stovall says. The May-October period is traditionally quite volatile for stocks and market volatility also tends to increase as bull markets age. If the U.K. votes to exit the European Union, stock prices could take a hit, Stovall says. "But, I don't see the U.S. falling into a new bear market," he adds. Nevertheless, Stovall says these are two steps investors might study in the next week.

Put together a shopping list. "Identify investments you want to purchase if share prices fall," Stovall says.

Watch defensive sectors. Stovall highlights the health care and consumer staples sectors, which he says have the potential to outperform the broader market if we see a seasonally weak period of May through October. Over the past 25 years, the health care sector posted an average return of 4.5% in the May-October period versus a 1.5% gain in the S&P 500 during that time period, Stovall says. You can read more about Stovall’s views on sectors here.

Finally, don't let volatility scare you. Warren Buffett once famously said: "Be fearful when others are greedy and greedy when others are fearful." Learn about ways investors can trade volatility here.

TD Ameritrade clients can monitor global government bond markets in the thinkorswim platform. For instance, the chart in figure 1 shows an index that tracks the German Bund. And remember: bond prices move inversely to yields. The move higher in figure 1 shows prices rising, while yields were falling. 

FIGURE 1: 3-YEAR RISING TREND IN GERMAN BUND.

The German Bund reached a new high in price, low in yield, last week as investors grew worried over the U.K. voting to leave the European Union. Chart source: the TD Ameritrade thinkorswim® platform. For illustrative purposes only. Past performance does not guarantee future results.

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