The Black Swan Has Arrived - Markets In Collapse

| About: Bank of (BAC)

Summary

The first of my three potential Black Swans of 2016 has arrived: BREXIT.

The UK’s vote to leave the EU creates massive uncertainty from a political and financial standpoint.

The stock prices of many global systemically important financial institutions collapsed on Friday and need to be monitored closely in the days and weeks that follow.

On Thursday, citizens of the United Kingdom took to the polls and did the unthinkable by voting to leave the European Union. Not surprisingly, asset prices across the financial-markets universe reacted violently.

The Dow Jones Industrial Average (NYSEARCA:DIA), S&P 500 (NYSEARCA:SPY), and Nasdaq (NASDAQ:QQQ) fell 3.39%, 3.59%, and 4.12% respectively on the day after the vote. European stocks fared much worse. The iShares MSCI Germany ETF (NYSEARCA:EWG) fell a whopping 9.79% on Friday, while the iShares MSCI France ETF crashed 11.36%. In the world of currencies, the British pound (NYSEARCA:FXB) cratered, at one point falling from its Friday high of 1.5009 to 1.3246, before settling at 1.3666. Given the surging dollar (NYSEARCA:UUP), it wasn't surprising to see the energy complex take a beating, with oil (NYSEARCA:USO) closing down about 5%. There were three bright spots on the day, though not the kinds of bright spots most investors would cheer. Gold (NYSEARCA:GLD) surged $94 before settling up $55.20 at $1,316.40. Treasury yields generally plunged, with the 10-year (NYSEARCA:IEF) falling to 1.56% and the 30-year falling to 2.41%. And volatility soared, with the VIX up 49.33%. Unfortunately for those who like to partake in what I call the shoeshine boy trade, buying XIV, the VelocityShares Daily Inverse VIX ETN, Friday was a horrific day as the ETF fell 26.79%.

A couple of days before the BREXIT vote, I wrote the 3,700 word piece "3 Black Swans That Could Devastate Stocks." Black Swan number one was a UK vote to leave the EU. The other two Black Swans are due to arrive later in 2016. Since the vote, both the mainstream financial media and the financial blogosphere have inundated investors with BREXIT-related commentaries. After perusing many of the commentaries, I thought a slightly different perspective from those that I came across was in order. Hence, concerning BREXIT, I'd like to offer the following thoughts:

Confidence Utterly Destroyed

The vote to leave the EU has utterly destroyed confidence on many levels.

First, the inviolability of the European Union is now being called into question. Already, we are hearing calls from politicians in other countries for similar referendums in the Netherlands, France, Italy, and Denmark.

Moreover, not only is the future of the EU being called into question, but the future of the United Kingdom as well. Scotland, which voted 62% in favor of Remain, will not take kindly to being forced out of the EU. Already there are calls for another Scottish independence referendum. Similarly, Northern Ireland voted rather decisively in favor of Remain (55.8% voting Remain) and questions abound as to whether that country will also attempt to break away from the United Kingdom. Today, there is a very divided United Kingdom, a United Kingdom nobody can be sure will survive in its current form.

Without the ability to handicap what Europe will even look like in the coming years from a political/sovereign structure standpoint, it is impossible to invest with any confidence in stocks, real estate, startups, junk bonds, or pretty much anything else tied to Europe. People who tell you they are buying for the "long-term" are simply trying to justify their desire to put money to work, rather than actually thinking through the long-term consequences of what just happened. Anyone who is serious about long-term investing in today's political, economic, and financial-markets reality would be more inclined to shy away from investing in stocks for the time being, not only because of the massive uncertainty created from BREXIT but also because of valuations that imply very low future returns. And yes, when it comes to stocks, I am also referring to U.S. stocks. Here's why:

BREXIT has unleashed the very real potential for severe stresses in the global financial system. This is very easily illustrated by simply looking at Friday's stock price performances of some of the globe's systemically important financial institutions. Barclays (NYSE:BCS) and the Royal Bank of Scotland (NYSE:RBS) fell 20.48% and 27.50% respectively. Let me make this crystal clear. Those massive declines from those two particular banks alone is reason enough not to put a penny into stocks at this time. Banks of that size don't decline on that order of magnitude without investors starting to ask serious questions as to the health of the banks. Any serious issues pertaining to the health of Barclays or Royal Bank of Scotland will have repercussions for the global financial system. And there is no way the United States economy or the U.S. stock market can escape serious issues in the global financial system.

Continuing on, Deutsche Bank (NYSE:DB) and Credit Suisse (NYSE:CS), also global systemically important banks, suffered steep declines on Friday, falling 17.49% and 16.11% respectively. They aren't even British-based banks, so why the concern? Not only were Deutsche Bank and Credit Suisse surely sold because of concerns about the future of the EU, but remember also that we live in a globally connected world. The financial crisis of 2008/09 illustrated this perfectly as institutions which thought they were well capitalized and would easily survive suddenly found themselves on the brink of disaster. Serious concerns about Barclays and RBS will undoubtedly cause contagion across the European banking system and then the global banking system. This helps explain why Citigroup (NYSE:C), Bank of America (NYSE:BAC), JPMorgan Chase (NYSE:JPM), Goldman Sachs (NYSE:GS), and Morgan Stanley (NYSE:MS) also got crushed on Friday, down 9.36%, 7.41%, 6.95%, 7.07%, and 10.15% respectively.

Keep in mind that a one-day selloff doesn't alone portend ongoing disaster. But it is enough to give prudent investors pause and is enough to cause very real concerns for the coming days and weeks. The very first thing I will be checking each day next week is the prices of the banks mentioned in this commentary, especially the European ones. If this type of equity destruction continues, one can only assume that short-term funding issues will follow as investors worry there's something they don't know about the banks and pull back. I realize the ECB says it is ready for all contingencies. Pardon my skepticism . . . I've heard that story before. I lived through 2008. I'll believe it when I see it.

Massive Uncertainty

I mentioned the word "uncertainty" seven times in my article linked above; and for good reason. Wall Street hates uncertainty. The UK's voting to leave the EU has created huge amounts of uncertainty, some of which will likely be resolved very soon (the banks will either stop going down soon or their end will come soon) and some of which will take months and years to resolve. In addition to the massive uncertainty caused by BREXIT, if there's one thing investors should take away from the UK's vote to leave the EU, it is that the global status quo has suddenly changed in a big way. When the status quo changes, the future changes.

I'm sure there are plenty of investors who won't care about BREXIT and will plow money into stocks simply because in the past that was a smart thing to do. Before you do, however, if only as an exercise in prudence, you might consider reading the fine print in the various financial literature you've likely come across over the years. In it, you will likely find something similar to the following: Past results are not indicative of future results. Keep that in mind as you navigate the political, economic, and investing realities of a post-BREXIT world.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I am long BAC, JPM, and C bonds. I am also long Treasury bonds and gold.