Beyond Brexit: What Happened, What's Next

by: Michael Loewengart

Summary

June was a momentous month for the markets—and that’s putting it mildly.

The biggest driver of market action was “Brexit,” the historic vote by Britain to leave the EU.

Here's a look at how markets reacted, as well as what to keep in mind going forward.

A Closer Look

June was a month for the history books. Great Britain voted to exit the European Union (E.U.), becoming the first country ever to do so. This rattled investors globally, and created significant volatility in world markets. By the end of the month, developed international markets had lost nearly 3½% -- a significant drop, but well off their lows. Elsewhere, U.S. and emerging markets defied expectations and recovered nearly all their post-Brexit losses by June 30th. There was also dramatic action in bonds, as fixed income investors scooped up assets they perceived to be less volatile.

Britain's big decision: The long-awaited Brexit vote -- the referendum on whether Britain should leave the E.U. -- took place on June 23rd, and amid historic voter turnout, the "yes" vote prevailed. As previously noted, many who voted for Brexit claimed that Britain would be able to negotiate better trade deals and have stronger control over its borders. Those who voted to stay believed that leaving would result in years of uncertainty and significant negative economic consequences. Apart from the opposing arguments, though, one thing's for certain: The decision caused at least short-term upheaval in world markets, and will be an influential factor in the world economy for years to come.

Fed holds the line on rates: At its June meeting, the U.S. Federal Reserve decided to hold interest rates steady due to mixed economic data. While inflation and unemployment remained low, both job growth and gains in gross domestic product had slowed. And all this came before Brexit, which many economists believe will steady the Fed's hand on interest rates throughout the remainder of 2016. The vote introduced significant uncertainty into world markets.

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Domestic Equities

The Brexit outcome sent shivers through U.S. markets in June, triggering a drop of as much as 5% in the large-cap-oriented S&P 500 just two days after the vote. But domestic markets soon bounced back, and by month's end, the impact was muted. In fact, the S&P 500 ended June with a slight advance, gaining 0.26%. The index is now up 3.84% for the year so far.

U.S. small caps were also close to flat for the month, with the small-cap-oriented Russell 2000 Index shedding just 0.06%. Year to date, the index is up 2.22%.

The performance of the sectors that make up the U.S. equity markets (based on the S&P 500 sector indexes) showed evidence of a flight to safety in June, as defensive sectors did best. Telecom, utilities, and consumer staples were the best performers for the month, while financials, IT, and consumer discretionary were weakest. (Financial companies struggled with lower interest-rate expectations and Brexit-related uncertainty.) The story continues to be similar year to date, with telecom, utilities, and energy the strongest, and financials and IT lagging.

Turning to the equity styles, value stocks continued to significantly outperform their growth-oriented counterparts for both the monthly and year-to-date periods. This is based on the performance of the Russell 3000 Growth and Value Indexes.

International Equities

Volatility reigned in international markets in June, as the Brexit vote shook investor confidence around the globe. By month's end, however, emerging markets had essentially shrugged off the news, while developed markets were broadly lower.

The MSCI EAFE Index, a widely followed measure of developed market performance, bounced off steep lows to close the month down 3.36%. All regions of the index were lower, but in U.S. dollar terms, Europe and the U.K. posted the biggest declines. (Some British indexes reported gains for the month, but these were priced in pounds sterling, which dropped significantly relative to the dollar.) Year to date, the index is down 4.42%.

On the bright side (and in spite of Brexit), the MSCI Emerging Markets Index continued to be a strong performer. Thanks to strength in Latin America, it advanced 4.00% in June, the best showing of any major index we track. Emerging markets are also in positive territory year to date, up 6.41%.

Why so much strength post-Brexit? It could be that investors were able to look past immediate worries, and assess the vote's longer-term winners and losers. Plus, Britain's exit from the E.U. is going to be a long, carefully negotiated process, and there's still a lot to learn regarding how it will play out.

In June, when all was said and done, investors may have been willing to withhold judgment. The E.U. won't begin exit talks until it receives formal notification, which Britain has yet to deliver -- and likely will not do so until a new British prime minister is in place.

Fixed Income

Fixed income markets shifted dramatically in June, as investors sought safe-haven opportunities. The Barclays U.S. Aggregate Index surged 1.80% for the month -- and is now up 5.31% year to date.

In the U.S. Treasury arena, the yield on the benchmark 10-year note fell 35 basis points in June -- to 1.49%. (A basis point is one one-hundredth of a percent.) It may be worth noting that the 10-year yield is now lower than at any point since 2012, possibly suggesting concerns among bond investors about the broader economy. The shape of the yield curve, however, did not change meaningfully during the month.

Given the sharp downward move in yields, it's no wonder that long- and intermediate-term Treasuries were the strongest fixed income sectors in June. (Bond prices move inversely to yield levels.) T-bills, short-term Treasuries, and high-yield corporate bonds (also known as junk bonds) were the weakest, though all categories advanced for the month. Similarly, on a year-to-date basis, long-term Treasuries have been the best performers, while T-bills have lagged.

The Bottom Line

It may be quite some time before anyone understands how Brexit will play out. The true economic and investment impact will depend on the details of any exit settlement reached between Britain and the E.U., which may take years to come into focus.

So what should investors do in the meantime? As with any major geopolitical event, market movement is difficult to predict. But here are a couple ideas for consideration:

  • First, take a close look at the fixed income portion of a portfolio. Is there sufficient exposure to bonds? Even at today's low yield levels, fixed income investments may serve as a welcome buffer during times of turbulence. If there is concern about yields moving higher, consider the benefits of shorter-term bonds, which tend to decline less if interest rates rise.
  • Second, don't let Brexit be the sole determining factor. While some global investments took a beating in June, international exposure may be essential to a well-constructed portfolio. The reason for this, as Brexit has shown, is that U.S. and global markets don't always move in lockstep. For instance, if U.S. stocks should enter a sustained downturn, international equities may move in the other direction, providing ballast when it's needed the most. Plus, investing in uncorrelated assets may reduce risk across an investor's overall portfolio.

As always, maintaining a long-term point of view is critical to riding out short-term volatility. This can be made easier by owning a broadly diversified portfolio -- one that's well-aligned with an investor's personal goals, time horizon, and risk tolerance.

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. I have no business relationship with any company whose stock is mentioned in this article.