An Update on the Effects of Brexit

Do you remember Brexit? That was when a majority of those casting votes in the United Kingdom were in favor of leaving the European Union.

The initial forecasts were that the vote would be both a short-term and a long-term disaster for the United Kingdom and Europe. Global markets for risk assets (stocks, commodities and real estate) declined sharply for two days after the vote. Government bonds, especially U.S. Treasury bonds, rose in value as their interest rates declined. The vote triggered a flight to safety as investors feared the worst.

Several funds that invest in U.K. commercial property announced they would stop accepting new investor money and were looking at winding down their operations. Management of the funds believed that the vote would lead to a sharp decline in U.K. commercial property values.

Well, the negative effects that were feared haven’t happened, at least not yet.

One factor is that the Bank of England aggressively eased monetary policy right after the vote. Also, the U.K. economy was in fairly good shape before the vote. Of course, after a few days it became clear that it would be a long time before the United Kingdom actually left the European Union. The United Kingdom has yet to formally notify the European Union of its plans to exit. European Union leaders have made clear that they plan to draw out the negotiations and perhaps be very tough on exit terms. The exit and its consequences aren’t imminent. Some theorize that European Union leaders plan to be so unreasonable about exit terms that U.K. leaders won’t reach an agreement with them and might ask for a new referendum on the issue.

Now, interest rates are lower than before the vote, stock prices are higher and the pound has a lower value. All that should help economic growth in the short term.

The U.K. economic data also are very different from what the majority forecast after the vote. The data released since the Brexit vote have been consistently and substantially higher than expectations. Gross domestic product (GDP) has been above projections.

Market data indicate that investors continue to expect the long-term consequences to be negative. I suspect that expectation also is worse than the actual results will be, though Brexit should have negative effects for both the United Kingdom and Europe. But this is another example of how investors can be hurt badly by being certain what the future holds and investing based on forecasts.

The Data

Manufacturing continues to be bumping along a bottom, according to the recent data. The PMI Manufacturing Index mid-month flash report was down a little bit to 51.4. A reading above 50 indicates continued expansion, but it is at a weaker rate than last month.

The Dallas Fed Manufacturing Survey turned in a positive Production Index of 16.7, for a couple months of positive results. But the General Activity Index from the survey was a negative 3.7. That’s better than last month, but still negative. Most of the details of the survey were flat or negative.

Likewise, the Richmond Fed Manufacturing Index registered a negative 8. That’s better than last month, indicating some improvement in the sector, but it still is negative. Most of the components of the index were negative or flat, with employment being the weakest.

Durable Goods Orders were unchanged, and last month’s 4.4% increase was revised down to 3.6%. After excluding transportation, orders declined 0.4% and are down 1.1% over 12 months. Core capital goods, which are a good indication of basic business investment, increased 0.6% for the month but are down 3.1% over 12 months.

The nonmanufacturing sector is plodding along, according to the PMI Services mid-month flash index. The index rose one point to 51.9. This indicates modest growth but a little bit more growth than last month. The ISM Nonmanufacturing Index will be issued next week.

Housing continues to have generally positive reports. New home sales declined 7.6%, but that was after a significant 12.4% increase last month. The new number still is a very high rate of sales. The sales were helped by price declines of 3.1% for the month and 5.4% in the last 12 months.

Home prices were flat, according to the S&P Case-Shiller Home Price Index. They were up 5.0% over 12 months. The nominal average home price now is only about 2% less than the bubble peak, but when adjusted for inflation, the average home price still is about 16% below the bubble peak.

The Pending Home Sales Index from the National Association of Realtors declined 2.4% for the month. In recent months, new home sales have been strong while existing home sales have been weak. But both suffer from low inventories of homes available for sale.

Consumer Confidence as measured by The Conference Board registered a nice increase to 104.1. This is substantially above expectations and is a new high for this recovery. Consumer confidence and sentiment surveys often are good indicators of household spending over the next several months.

New unemployment claims rose a modest 3,000. That keeps the weekly number and four-week average near historic lows.

The third estimate of second-quarter GDP was increased a bit to a 1.4% annual growth rate. The rise was due to an increase in the estimate for nonresidential fixed investment. Improvements in estimates for consumer spending and exports also boosted the estimate.

The Markets

The S&P 500 returned 0.38% in the week ended with Wednesday’s close. The Dow Jones Industrial Average increased 0.24%. The Russell 2000 rose 0.89%. The All-Country World Index increased 0.34%. Emerging market equities rose 0.26%.

Bonds had a strong week. Long-term treasuries were up about 1.86%. Investment-grade bonds increased 0.80%. Treasury Inflation-Protected Securities (TIPS) increased 1.02%. High-yield bonds rose 0.74%.

The dollar lost 0.12%.

Energy-based commodities rose 0.90%. Broad-based commodities were unchanged. Gold lost 0.70%.

Bob’s News & Updates

It looks like my final speaking engagement of 2016 will be the new MoneyShow Dallas Oct. 20-21. Registration is free.

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Some Reading for You

One of the investors who profited from the housing collapse evaluates current trouble sectors of the markets.

Investor Meb Faber examines current valuations to anticipate likely future market returns.

Some analysts are saying the TED Spread indicates upcoming troubles for stocks. This post analyses the arguments.

I comment and link to these and other items on my public blog at http://www.bobcarlson.net.