2nd Quarter – 2016 Market Review Letter – What’s a Brexit & Why Does it Matter?

Just three months later, the pain and anguish of the first quarter seem like a distant memory.  The recovery that started in mid-February continued through the second quarter, with parts of the stock market ending the quarter near record highs and bond yields near record lows.  

But the last couple weeks of the quarter brought the greatest volatility as the people of Britain voted to leave the European Union, a surprise result.  Thus, the “Brexit” has been dominating recent headlines.  While Britain leaving the EU is likely to be positive for Britain (in our opinion), the uncertainty created by this move rattled the markets and more volatility is likely as the details of the exit are negotiated.  It also opens the door for other countries to leave the EU, which could lead to the unraveling of the entire arrangement and even more uncertainty.

Predictions regarding the ramifications of Brexit are all across the spectrum, from utter collapse of the British Empire and EU to positive ramifications of new economic freedoms & less restriction.  

The fact is, the market hates uncertainty.  Uncertainty is to the market what kryptonite is to Superman.  Even if none of the likely potential outcomes are particularly bad, the market still panics in the face of uncertainty.  Even if the likely potential outcome is bad, the market loves the certainty.  But the reality for long-term investors is not all uncertainty is bad.  In fact, some of it is very good, especially when it gives us great investing opportunities.  

Positives

  • Employment continued to be steady with the unemployment rate dipping below 5% even though job growth has slowed the last few months.
  • Low oil & gas prices continue to save money for consumers.
  • Oil & gas rig counts have been increasing over the last few weeks, which will help jobs numbers if the increase continues.
  • Housing has continued moderate but choppy growth.  There still seems to be plenty of pent-up demand.

Challenges & Risks

  • Oil prices declines are still working through the system and we are seeing the expected defaults from many energy companies.  
  • Oil continued its rise, hitting over $50 in recent weeks.  This likely spells the end of sub-$2.00 gas in the near future.
  • Interest rates – the Federal Reserve still did not raise interest rates in June and now only expects one or two increases for the year.  Either way, it is uncertainty for the market.
  • Corporate earnings have been weaker than expected & tough weather is not a good excuse this year.

The first half of the year has been quite the roller coaster ride.  We believe this volatility is actually more “normal” than what we have experienced over the last several years and is likely here to stay.  

As Peter Lynch said, “A stock market decline is as routine as a January blizzard in Colorado.  If you’re prepared, it can’t hurt you.  A decline is a great opportunity to pick up the bargains left behind by investors who are fleeing the storm in panic.”  A239