Market Strategy Radar Screen Weekly July 11, 2016

Take It Back to Where You Once Belonged

We quote the Beatles after the S&P 500 index stopped
short of making a new all-time high

Meanwhile “across the pond” voters in the UK were finding that “you can’t turn back the hands of time” as their country’s leadership dismissed hopes they’d consider some 4,000,000 petition signatures proposing a “redo” of the June Brexit referendum.

Brexit, while not likely to become an economic tragedy, will most likely be disruptive beyond current assumptions due to the complexities of the unwinding necessitated to effect the UK’s divorce from the EU.

As with most divorces that are rife with contention, the only certainty this early in the process appears to be that the lawyers and negotiators will profit handsomely from it and that businesses and individuals will ultimately bear the costs of the process to growth near term.

In meetings last week in the UK and on the Continent with professional investors we found most were as we’d been─taken by surprise by the results of the referendum. The very impracticality and economic cost of initiating an exit from a regional trade agreement of the magnitude of the UK’s membership of the EU would have seemed to dissuade pragmatic individuals from opting for such an exit.

In hindsight the reality is that when it comes to politics, it seems that nationalism, populism, emotions and fear of the unfamiliar too often reign and that pragmatism falls by the wayside or is at best placed far down the line for consideration in making important decisions.

In the aftermath of the referendum the UK business people we spoke with who import goods from the EU had almost immediately found their costs rising as the value of the pound fell. They were also finding next to nil opportunity to pass their increased costs onto their UK customers who were grappling with their own post Brexit vote concerns.

Citizens of the EU residing and working in the UK for domestic companies over the past few years are suddenly finding themselves wondering how their status as EU citizens working in the UK will be defined in the new order that comes from the exit process. Others working for firms that are likely to move headquarters to the opposite side of the channel are also dealing with incertitude.

Overall there was a feeling of disappointment and even sadness at the results of the referendum vote as well as a concern over what it portends in the months and even years of adjustment that lie ahead.

The issues surrounding immigration and sovereignty appeared to be understood (even empathized with) by those who had opposed Brexit. The thought generally was that voting to exit the EU was an overly drastic response to concerns over issues tied to immigration and sovereignty particularly when considering the economic repercussions near term and perhaps through much of the process of the exiting.

However, beyond the concern that we came across in our conversations was generally a feeling that somehow historic precedence, the mechanisms of trade and the markets, along with ongoing and future negotiations would prevail, providing a workable solution for the UK and the EU. The problem lies in the uncertainty that hangs over the landscape for now.

In our talks with investors last week they were finding diversification including investments in US stocks offering a suitable offset to the challenges in Europe and the UK. The recent resurgence in the strength of the dollar has also helped to boost returns from their investments in the US.

Meanwhile, back in the USA…

Stateside last week stocks got a boost from the release of the non-farm payroll number for June which at 287,000 jobs added (versus a Bloomberg survey of economists that called for 180,000 jobs) substantially exceeded expectations.

Investors reacted positively to the release pushing stocks higher (near record highs respectively for the Dow Jones Industrials and the S&P 500) regaining earlier losses from the Brexit results and from other earlier growth concerns.

Fed funds futures jumped on the news with prospects rising to 20% for a Fed hike as early as December. We had been and continue to be of the opinion that the Fed will raise once this year in December and then no more than 25 bps.

As much as the Fed might like to push the normalization of rates ahead, the strength of the dollar, slow growth abroad, low rate of wage reflation and worldwide lust for yield (which could push the dollar higher) keep the Fed highly sensitive of the landscape.

Other economic data that helped to support the rally in stocks last week included the nonmanufacturing ISM index, which rose in June to a level of 56.5, which was above consensus expectations and was up from 52.9 in May. That data pointed to the economy’s main driver’s resilience to weakness in manufacturing (caused by the dollar and sluggish global growth) as well as helped ease concerns about the possible effect of Brexit on the US consumer.

The initial jobless claims for the week ending July 2nd came in below expectations with the four-week average near the lows last registered in the early 1970s. The indication is that employers continue positive on the sustainability of the economic expansion.

Also supportive of stocks last week was a further decline in yields among fixed income product as the 10-year Treasury yield fell to a new alltime record low of 1.36% last Friday (see figure below).

With the economy averaging a little over 2% growth per year on average since the recession ended in 2009 a combination of modest growth, low interest rates and improvements in jobs, housing and autos could help keep the stock market grinding higher.

Last week the MBA Mortgage applications jumped 14.2%.

A mantra we’ve adapted since the recession ended in 2009 and the economy’s and the market’s performance improved with resilience and consistency has been, “no boom, no bubble, no bust…we’ll take it.”

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