Value In A Post-Brexit World

| About: SPDR S&P (SPY)

Key points

  • Indiscriminate selling after the U.K. Brexit vote may create opportunities in assets with positive fundamentals and relative value (such as quality and dividend-growth stocks).
  • The U.K.'s shock decision pummeled global risk assets and the British pound, and buoyed safe-haven assets.
  • We expect economic data this week to show poor U.S. jobs growth in May, it wasn't a harbinger of a U.S. recession.

A British vote to exit the European Union (EU) has spurred a flight to safety, potentially creating opportunities. With most asset valuations looking fair to expensive, however, it's important to focus on relative valuations.

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Prior to Brexit, there was a wide range of valuations but few cheap assets globally, as shown above. Modest economic growth, low inflation expectations and easy central bank policies have sent yields lower, intensifying flows into income-oriented assets. This partly explains acute valuation differences between equities and government bonds. Political concerns in Europe have exacerbated other extreme differences.

Selectivity and caution are key

Valuations tell us little about short-term returns but can potentially shed light on medium-term returns. Starting valuations explain roughly 10% of U.S. equity market returns over the following year but 87% of returns over the next 10 years, according to our analysis back to 1988.

Valuations also show the risk of owning bonds (and bond proxies) could rise further, as market uncertainty and easy monetary policy potentially drive valuations of interest-rate-sensitive assets higher. Some assets may be cheap for a reason, reflecting structurally challenged businesses for instance.

The big takeaway for those seeking to buy into market weakness: Be wary of notionally cheap assets that face challenges (e.g., domestically focused European assets like U.K. real estate and European banks), and instead focus on assets with relatively attractive valuations and positive fundamental drivers, such as quality stocks, dividend-growth stocks and investment-grade bonds. Indiscriminate selling of risk assets could translate into buying opportunities in these assets, including in U.K.-listed stocks that benefit from pound depreciation (72% of FTSE 100 revenues are earned abroad). Bottom line: Post-Brexit, selectivity and caution are key.

  • The U.K. vote to leave the EU pummeled global risk assets and the British pound and drove down safe-haven yields.
  • The vote set in motion a long period of political, economic, and market uncertainty for the U.K. and the EU.
  • Expectations of additional monetary stimulus in the U.K. and the EU rose, while the odds of a July Federal Reserve (Fed) rate increase plummeted.

Global snapshot

Weekly and 12-Month performance of selected assets

Equities Week YTD 12 Months Div. Yield
U.S. Large Caps -1.6% -0.3% -3.4% 2.3%
U.S. Small Caps -1.5% 0.0% -10.8% 1.5%
Non-U.S. World -1.2% -3.7% -15.5% 3.4%
Non-U.S. Developed -1.7% -6.9% -15.7% 3.7%
Japan -1.7% -8.2% -12.8% 2.6%
Emerging 0.1% 2.5% -16.9% 2.8%
Asia Ex Japan -0.3% -1.4% -17.0% 2.8%
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Bonds Week YTD 12 Months Yield
U.S. Treasuries 0.2% 4.8% 5.9% 1.6%
U.S. TIPS 0.4% 5.5% 3.7% 1.6%
U.S. Investment Grade 0.2% 6.8% 7.1% 3.0%
U.S. High Yield 0.5% 8.9% 0.8% 7.3%
U.S. Municipals 0.3% 4.2% 7.7% 1.6%
Non-U.S. Developed 0.0% 11.4% 11.1% 0.6%
Emerging Market $ Bonds 0.6% 8.6% 7.6% 5.6%
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Commodities Week YTD 12 Months Level
Brent Crude Oil -1.5% 29.9% -23.8% $48.41
Gold 1.3% 24.0% 11.9% $1,316
Copper 3.2% -0.1% -18.1% $4,698
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Currencies Week YTD 12 Months Level
Euro/USD -1.4% 2.3% -0.8% 1.11
USD/Yen -1.9% -15.0% -17.5% 102.22
Pound/USD -4.7% -7.2% -12.9% 1.37
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Source: Bloomberg. As of June 24, 2016.

Notes: Weekly data through Friday. Equity and bond performance are measured in total index returns in U.S. dollars. U.S. large caps are represented by the S&P 500 Index; U.S. small caps are represented by the Russell 2000 Index; Non-U.S. world equity by the MSCI ACWI ex U.S.; non-U.S. developed equity by the MSCI EAFE Index; Japan, Emerging and Asia ex-Japan by their respective MSCI Indexes; U.S. Treasuries by the Barclays U.S. Treasury Index; U.S. TIPS by the U.S. Treasury Inflation Notes Total Return Index; U.S. investment grade by the Barclays U.S. Corporate Index; U.S. high yield by the Barclays U.S. Corporate High Yield 2% Issuer Capped Index, U.S. municipals by the Barclays Municipal Bond Index; non-U.S. developed bonds by the Barclays Global Aggregate ex USD; and emerging market $ bonds by the JPMorgan EMBI Global Diversified Index. Brent crude oil prices are in U.S. dollars per barrel, gold prices are in U.S. dollar per troy ounce and copper prices are in U.S. dollar per metric ton. The Euro/USD level is represented by U.S. dollar per euro, USD/JPY by yen per U.S. dollar and Pound/USD by U.S. dollar per pound. Index performance is shown for illustrative purposes only. It is not possible to invest directly in an index. Past performance is not indicative of future results.

Asset class views

Views from a U.S. dollar perspective over a three-month horizon

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This post originally appeared on the BlackRock Blog.