The Brexit Panic Subsides

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It didn’t take long for the Brexit panic to subside. Markets for riskier assets (stocks and commodities) declined sharply for a couple of days, but then recovered most of those losses just as quickly. U.S. stock indexes did more than recover their losses, rising to new highs in the wake of Brexit.

This sequence of post-Brexit events is a good example of why we don’t invest on forecasts, predictions or the latest news. Markets are efficient, meaning that new information can be reflected in prices very quickly. But the conclusions drawn by the majority of investors are often wrong. Sometimes it doesn’t take long for the errors to be corrected, as happened with Brexit. Other times, it can take weeks, months or even years for investors to come to their senses. The technology stock bubble of the late 1990s is a good example of how markets were at odds with investment fundamentals for an extended period of time.

I suspect markets are wrong right now about U.S. interest rates and inflation. After investors spent several years anticipating that rates and inflation would return to normal levels relatively soon, they eventually gave up on that expectation. Current market prices indicate that investors expect rates and inflation to stay at or below current levels for years to come. As I explained in the July issue of Retirement Watch, I don’t think that’s likely to be the case. We are already seeing signs that interest rates and inflation in the United States are ready to increase again.

Interest rates and bond prices right now are distorted by the central bank reactions to the Brexit vote. All the central banks made purchases of bonds to ensure markets had a lot of liquidity. At the same time, investors engaged in a flight to safety and bought a lot of bonds. The flight to safety is over, and I believe the Fed will reduce its bond purchases. While European interest rates might stay low for quite some time to come, I no longer expect the same from U.S. rates.

The Data

Producer Prices had their second month of solid increases, rising 0.5% in the last month. The 12-month change is only a 0.3% increase. Excluding food and energy though, the one-month increase is 0.4%, and the 12-month change is 1.3%. The deflationary effects of declining commodity prices and the rising dollar clearly are behind us.

The Small Business Optimism Index from the National Federation of Independent Businesses (NFIB) increased for the third month in a row. The index stalled earlier this year, falling to a two-year low in March. This is another indication that the broader U.S. economy continues to grow and at a faster rate than was seen earlier this year.

Consumer Credit rose substantially, but most of the increase was in automobile and student loans. Even so, credit card debt increased by about $2.4 billion.

The Employment Situation reports generated a lot of headlines and market action, as they usually do. They also showed why investors pay too much attention to these reports. Employment is a lagging economic indicator, and the reports are subject to revision. May’s disappointing report of 38,000 new jobs was revised down to 11,000. However, the June report said 287,000 new jobs were created for the month. The unemployment rate rose because more people joined the work force.

I believe that the more important data from the June report was that hours in the average workweek didn’t increase, and average hourly earnings rose only 0.1%.

The JOLTS (Job Openings and Labor Turnover Survey) report is more detailed than the Employment Situation reports, but is lagged by a month. The JOLTS report for May was consistent with that month’s Employment Situation reports, showing fewer new job openings than the previous month and the lowest level since February. The layoff rate and hiring rates were unchanged though. The quitting rate also was unchanged, indicating that workers didn’t increase their confidence in the labor market by seeking higher-paying jobs.

New unemployment claims were 254,000, which is unchanged from last week. Both the weekly claims and four-week average are at historic lows. Economists say to anticipate an increase in these numbers in coming weeks because auto plants traditionally lay off workers in the summer in order to retool for the next model year.

The Markets

Stocks continued their recovery from post-Brexit lows, but most other investments lost ground this week.

Emerging market stocks rose 4.13% for the week ended with Wednesday’s close. The All-Country World Index gained 3.12%. The S&P 500 gained 2.51%. The Dow Jones Industrial Average returned 2.58%. The Russell 2000 led the major indexes with a 4.71% increase.

Long-term bonds lost 0.64% for the week. Investment-grade bonds gained 0.14%. Treasury Inflation-Protected Securities (TIPS) lost 0.59%. High-yield bonds followed the path of stocks more than bonds, as usual, gaining 1.51%.

The dollar gained 0.24%. Energy-based commodities lost 2.50%. Broad-based commodities lost 0.62%. Gold lost 1.52%.

Some Reading for You

This article discusses some of the often-overlooked benefits of exercise, regardless of one’s age or the intensity of the activity.

This article explains why new car prices are too high, and the findings are consistent with an article I wrote in the July issue of Retirement Watch

This article gives a good summary of five things investors are worrying about.

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