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Brexit Observations And The Markets

|Includes: SPDR Dow Jones Industrial Average ETF (DIA), GLD, QQQ, SLV, SPY, USO, UUP
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Brexit - The Single Biggest Market Driver and Two Observations By Dr. Van Tharp Trading Education Institute

"The most difficult subjects can be explained to the most slow-witted man if he has not formed any idea of them already; but the simplest thing cannot be made clear to the most intelligent man if he is firmly persuaded that he knows already, without a shadow of a doubt, what is laid before him." - Leo Tolstoy

"It ain't what you don't know that gets you into trouble. It's what you know for sure that just ain't so." - Derivation of Josh Billings often attributed to Mark Twain or Abraham Lincoln

On Thursday, six days ago, everyone knew that Great Britain was going to vote to remain in the EU after the Brexit vote.

The Dow Jones Industrial Average closed the day up 230 points as institutions, traders and investors looked at media sources assuring a "remain" vote to a coronation that would usher in a bull run on stocks and the British Pound. In after-hours trading, the Dow tacked on another 110 points for good measure.

Voter polls just a week before had shown the "leave" side slightly ahead, but by the day of the vote polls were widely reporting several percentage points advantage for the "remain" side. The betting odds published by the legendary British bookmakers were peaking at 80/20 in favor of remain.

But around midnight British time, the tenor started to change. The overnight futures markets started to sell off a bit as results started to trickle in. The rest of the night was much like a sporting event.

The "remain" team took an early lead and the futures market dropped precipitously. Ah, but the critical Scottish and London votes (where a strong "remain" outcome was expected) had not yet reported.

By a little past 2 a.m. British Summer Time (NYSE:BST), the leave votes had gained momentum and showed a 4 percentage point lead. The markets were down huge, the Dow having given up 530 points.

But then, in rode the cavalry - Glasgow delivered the expected huge margin voting two to one in favor of "remain". Scotland's largest city tipped the voting scale back to the "remain" side and as other Scottish votes came in along with some London districts, the Dow drove up 340 points over the next 30 minutes. Game on!

Over the next 60 minutes, however, the excitement quickly flew to the side of the "leave" backers as results from middle and northern England began the win the day. Much like a snake constricting its next meal, the results slowly but surely slid more and more to the "leave" side until all the breath was taken from the "remains"… and the market.

By 5:30 a.m. BST (12:30 a.m. EST) the Dow had given back a whopping 900 points from its earlier peak, but the U.S. stock losses were small compared to the double-digit losses suffered on bourses throughout Europe and the British Pound which was down an amazing 11+ percent.

The Single Biggest Market Driver - Get This

One key lesson that I've learned time and again is that there is one thing that drives big market moves more than anything else. You'll recognize it and most likely agree with it when you see it:

Surprise!

As the opening quotes indicate, when the collective intelligence of the market thinks it knows one thing, and then it gets another - the market acts in a big way.

We've seen it before - and we see it regularly played out every quarter in the earnings announcements cycle. When a company is expected to miss it earnings projections and instead announces an upside surprise - the stock skyrockets. The same thing happens for missed expectations.

Observation Number One

My first Brexit observation: a large part of the initial stock market move as the Brexit vote unfolded was due to the SURPRISE at the outcome. Everyone "knew" that the vote would be for Remain. The betting pools had been massively on the Remain side of the vote and so had the polls (albeit to a lesser extent).

That's not to say that the potential long-term ramifications of the vote didn't warrant a market move. If however, the common knowledge heading into the vote was that it was a coin toss too close to call or if the Leave crowd was favored to win, the market moves would have been much more muted.

Observation Number Two

During Friday's market drubbing, I got a lot of questions about whether it was time to sell stocks. I answered - let's hold on and see. By Monday afternoon, my answer was no, it's not time to sell and in fact, I was a buyer on Monday afternoon.

The reason? Our biggest short-term danger had passed. That danger was a liquidity trap - that institutions and traders who wanted (or needed) to sell would not be able to do so because buyers disappeared and volume would dry up. That didn't happen, and by Monday afternoon there were key signs that the danger had passed.

The biggest sign that the danger had passed was the volatility indicator VIX. Let's look at a weekly chart for SPY and the VIX:

SP500 Vix Volatility

The contained VIX is not an "all clear" signal - but just a sign that we absorbed this body blow in the U.S. markets and are now ready to absorb some non-Brexit news (and market fundamentals) for a while. Actually, the S&P has already climbed back into the sideways box where it was trading for 12 weeks before the Brexit vote so… we might expect more sideways grinding into the dog days of summer.

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