The markets have sure taken notice of the BREXIT leave vote. Granted, part of today’s strong stock decline is due to a globally pre-mature bet that Britain would vote to stay-with the Dow closing yesterday up 230 points in anticipation of a Stay Vote. With the announcement of Britain’s vote to leave the EU, the Dow has not only lost all of yesterday’s gains, it has also lost an additional 270 points in mid-day trading, bringing it down 500 points from yesterday’s close. The reason? Markets hate uncertainty and the “leave” vote has created just that. How will the British economy be impacted? Will it encourage other members like France and the Netherlands to leave?
The process of Britain leaving the EU could take up to two years, meaning the effects will definitely not be immediate. However, not knowing exactly what the impact of this change will be on the global and regional economy is behind the markets’ reaction. The VIX, which is a common measurement of volatility in the stock market and is historically counter-cyclic to the market, has been elevated all year primarily due to crashing commodity prices, historically weak growth in China, negative interest rate policies and a US economy that grew very mildly to start off the year. Britain’s separation from the European Union just intensifies the uncertainty in the global economy.
The potential impact on U.S. companies is certainly tangible. Many U.S. banks have set up large footprints in London as the financial gateway to broader Europe. Global companies often establish regional headquarters and production in the UK because of its access to the rest of Europe. Caterpillar, for example, has 16 major manufacturing facilities in the UK that sell into many other countries. While Britain may only account for a small portion of the USA’s direct trade, it’s connectivity to global markets makes the potential impact much greater. The UK may be a step further toward viewing itself more as an island and independent nation, but its economy is more internationally integrated than ever.
The leading indicators for the U.S. economy have long suggested weakness in the first half of 2016, the stock market reaction today is not changing that situation. We have been seeing some positive trends develop in our leading indicators, such as the Prevedere Retail Leading Indicator and Prevedere Consumer Package Goods Leading Indicator that suggest a recovery could be in store for the second half of the year. The rising trend in these indicators is influenced by consumer mood and business environment, so a sharp swing in long term thinking by the U.S. consumers and businesses could snuff out an early recovery, but it remains too early to say whether or not this will be the case. Yes, global stocks, currency and bond markets will appropriately and logically respond to the news (the pound has fallen, gold prices are up, dollar is up, stocks of multinationals are down) but this event alone can’t send the U.S. into recession. Unfortunately, this event comes at a time when the U.S. economy is already fragile so we will continue to watch our leading indicators for any change in non-stock market indicator momentum caused by the Leave Vote.