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British Shock – “Brexit” and What’s Next?

Brexit shock

Britain shocked the financial community by voting to leave the European Union (EU) on June 23. The initial shock of the unexpected outcome prompted a sharp decline in stock markets around the world and we believe it may take some time for the shock to fully work through the economic, financial, and political systems in the United Kingdom and Europe. With no visible catalyst to halt the slide, the decline in global stocks may continue, as the risk of a global recession increases.

Short-term focused traders should be prepared for further stock market declines over the next three-to-six months, similar to past shocks since 2009. We continue to believe volatility will remain a major characteristic of markets in 2016. However, longer-term investors may want to maintain their diversified asset allocations intended to weather volatility on the way to longer-term goals.

Back in the United States

We remain neutral on U.S. equities and believe that the market will ultimately recover, but near-term uncertainty will likely contribute to more volatility and the possibility of additional sharp pullbacks.  However, with recession odds still fairly low, we still don’t envision a prolonged bear market.

The great unknown
Bumpy…but not bearish

The U.S. economy is hanging in there. However, should the impact from the British vote become harsher than currently expected, we may be forced to downgrade our longer-term view of both the U.S. economy and equities.

The weak May jobs report concerned investors (and the Fed), but other employment-related data released since then—like unemployment claims—support the idea that it may have been an outlier, not the beginning of a significant deterioration in job growth. We do believe that job growth is naturally slowing given the maturity of the economic expansion and the fact that there are fewer available and/or appropriately skilled workers.

The apparent tightening of the labor market, with the standard measure of unemployment now at 4.7%, is helping to boost wages. This is bolstering the U.S. consumer as the strong April retail sales report was followed by another solid report for May. Additionally, the housing market appears to be strengthening as elevated rental costs, aging Millennials, improved consumer confidence, and exceptionally low mortgage rates move more folks into home purchases.

The corporate side of the U.S. private sector continues to struggle to gain momentum, and manufacturing continues to flirt with contraction. The uncertainty associated with Brexit has caused the U.S. dollar to surge again and could exacerbate the manufacturing sector’s problems at least in the short-term. Although a couple of regional manufacturing surveys inched back into expansion territory, according to the Federal Reserve industrial production fell again in May by 0.4%, while capacity utilization moved lower to 74.9 from 75.4—more than five percentage points below its longer-term average. And the continued extreme interest rate environment seems to us to be influencing corporate decision making—although likely not in the way policy makers were hoping. Stock buybacks and increased dividend payments seems to be the choice of many companies, while they remain reluctant to invest substantially in equipment and material that has longer-term potential benefits.

Fed stands ready to help

The Fed is unlikely to raise rates in the foreseeable future, and could look to add some sort of support to the economy or financial institutions if needed.

So what?

The next several weeks could be a tumultuous time in global markets, and investors need to keep a longer-term view in mind. Global stock markets have tended to ultimately rebound from other sharp declines—often fairly quickly. It can be tough to get back on track once things reverse, so we recommend investors use volatility to tactically keep allocations in line with their long-term strategic targets.

Important Disclosure
This material is issued by Charles Schwab, Hong Kong, Ltd. The information provided here is for general informational purposes only and has not been reviewed by the Securities and Futures Commission in Hong Kong.

Content provided by Charles Schwab, Hong Kong
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