What A Brexit Vote Means To Britain And The World

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The big news last week was the Fed’s Federal Open Market Committee (FOMC) meeting, where they decided to leave key interest rates unchanged. The FOMC signaled that they would now take an even slower path to normalizing rates, lowering their 2016 GDP forecast to 2%, down from 2.2% previously estimated. At a press conference, Fed Chairman Janet Yellen acknowledged that “vulnerabilities in the global economy remain” and emphasized that “our cautious approach to policy remains appropriate.”

Yellen also said that the Fed would closely monitor the June employment data, due out in early July, for evidence that hiring has rebounded after a surprising slowdown in May and April. It is crystal clear that the May payroll report and the previous month’s downward revisions caught the “data dependent” Fed flatfooted, which is why the FOMC is now so cautious with its guidance. When asked about a July rate hike, Yellen said it was “not impossible,” a convoluted Fed-speak phrase by a clearly frustrated Yellen.

Interestingly, only six of the 17 FOMC members now expect just one rate increase this year, vs. the four rate hikes they expected last December. In barely six months, the Fed has done an abrupt about-face and unwound its previous hawkish guidance. Not surprisingly, 10-year Treasury bond yields declined below the 1.6% level after the FOMC statement and Yellen’s comments. Overall, it is unfortunate that the Fed has contributed to financial market volatility this year by being hawkish in December and dovish now.

In America, both the Fed and the financial markets remain very concerned about Brexit. The flight of capital out of Britain is so severe that 10-year German government bonds hit a negative yield of -0.006% and joined Japan and Switzerland as the other major countries with negative 10-year bond yields.

If Britain votes to exit the European Union (EU), it will likely weaken the euro as well as the British pound, since speculation will mount regarding which other countries will want to exit the EU next. Since Britain held onto its own currency, it is much less messy for the Brits to exit the European Union. However, for those countries that share the euro, exiting the EU would be a fiscal disaster, since setting up a new currency and central bank is not easy and likely more trouble than exiting the European Union.

At the heart of the problem between Britain and the European Union is growing resentment against all the changes that Brussels is mandating, such as the new refugees that are overwhelming British schools and further undermining their national healthcare system. Britain also worries about losing its national identity and heritage, of which it is immensely proud.

The view from the United Kingdom is that all the regulations that Brussels is imposing are being influenced most by mighty Germany. Even though Germany is viewed as a disciplined, well-run country, clearly not everyone in Britain wants to become more Germanic in nature. Overall, the European Union has been an interesting experiment, promoted by Germany to make Europe stronger; but in the end some countries do not want to lose their national identity and that will likely be demonstrated on June 23rd if Britain votes to exit the European Union.

Another outcome of Britain exiting the EU is that the U.S. dollar will likely strengthen further, which will put new downward pressure on commodity prices, like crude oil and agricultural crops. As a result, companies that are sensitive to the U.S. dollar, like multinationals, energy, and materials-related companies, will likely suffer accordingly. Since energy, commodity, and materials-related companies have performed relatively well since the February 11th lows, this means that a massive shift in market leadership is likely, especially if the U.S. dollar continues to climb and deflationary fears mount.

I should add that even though gold prices tend to decline when the U.S. dollar rallies, primarily because gold is priced in U.S. dollars, this time around I expect that gold will continue to perform well due to the related concerns about Brexit, negative interest rates around the world, and the growing impression that central banks have dug themselves a hole with negative interest rates and quantitative easing with no viable exit plan. I am not a fear monger, but if there is ever a “domino event” that freaks out financial markets around the world, it might be triggered by Brexit and the disintegration of the European Union.

Nationalism is Rising Everywhere – Even Here

There is no doubt that nationalism is on the rise around the world as many fear losing their national identity. Even though free trade helps to improve global living standards, globalization might have happened too fast, since many folks do not think that they benefit from global trade. In the U.S., where middle class incomes have not improved for over 15 years, many folks are frustrated, which is why our Presidential election this year seems so wild. Nationalist candidates have been surging all over the world as countries reject globalization and take pride in what makes their respective countries unique.

In politics, you do not have to necessarily be “right” anymore, just mad as hell; so all I can tell you is that when Hillary Clinton debates Donald Trump, it may be higher-rated than a Super Bowl. In a normal Presidential election year, candidates run around and suck up to voters by promising anything and everything, smiling all the while. This time around, however, I suspect that the insults will just increase. Negative ads will intensify and relentless attacks will not end until after the November elections, if then.

Normally the stock market rallies into Presidential elections, with rising consumer confidence, which then rubs off on investor confidence. However, deep anxieties about terrorism, the economy, opportunity, and equality will likely rise this time around, so it will be interesting if opening these wounds and exposing all our national problems so openly and forcibly will weigh on consumer confidence. All I can tell you is that, like most Americans, I believe what is about to unfold is going to be very entertaining and even over the top. Like Britain has endured in the run-up to Brexit, we are about to see over four months of scare tactics.

I should add that, due to all the chaos in the world as well as in the U.S., plus political uncertainty, there are multiple reports that cash on the sidelines is building. Even though companies are increasingly utilizing some of this cash to buy back their respective stock, the cash that investors and professional money managers are holding could help boost the stock market as soon as investors conclude that it is safe to invest. This flood of cash back into the stock market could begin whenever the uncertainty ends.

Whenever the Fed stops teasing us about rates, when the outcome of the Presidential campaign becomes clear, when (or if) the European Union’s chaos diminishes, then this pall of uncertainty should diminish. Investor confidence could then rise and much of that sideline cash could return to the stock market.

Naturally, I am taking no chances and making sure that I am “locked and loaded” with fundamentally strong stocks that will likely post better-than-expected results in the upcoming weeks and months.

Disclosure: *Navellier may hold securities in one or more investment strategies offered to its clients.

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