If you're feeling a bit bemused by "Brexit" as it relates to financial markets, you’re not alone. The passing of this event is so far eerily reminiscent of the “Year 2000 Problem/Bug” (aka Y2K), which also passed quietly into history.
Two days after British citizens voted to "leave" the European Union, stocks dropped sharply. Then the following three days the market rallied back to the levels they were at on the Thursday before the referendum was conducted.
If you’re a regular "tastytrader," you probably noticed that the VIX spiked hard during the market selloff on Day 1, and then proceeded to get absolutely decimated during Days 2-5. The VIX is now back to about 15, which is a precipitous drop from the 26-plus print on "Brexit" Day.
Prior to the “Brexit” referendum, I wrote in a previous post:
"Considering historical ‘surprises’ in the market, one would think that a ‘leave’ result might initially spook global equity markets and drive prices lower. However, if the all else remains the same going forward (Federal Reserve stays put in July), there may be room for a rebound as investors continue to grasp for yield/return in this negative-interest-rate-policy (NIRP) era."
In the excerpt above, I envisioned a rebound occurring over the course of a couple weeks or months, not a few days. But after the chaos of 2008-2009, who’s to say anything in the market these days is a “surprise.”
What’s more important to recognize is that we are still likely stuck in the paradigm of “government intervention.” I can recall a finance professor in graduate school warning our class that government intervention in markets increases the potential for uncertainty because it basically reduces the market’s efficiency.
In the current environment of heavy market support from worldwide central banks, which has involved negative interest rates and substantial quantitative easing, we seem to be stuck in a “bad news is good news” loop reminiscent of the old elevator music days.
A period in which bad economic or market-related news gets spun into optimism based on a belief that central bankers will be less likely to step down their support of the global economy based on X, Y, or Z.
“Brexit” seems to have played perfectly into the hands of the current trading regime in that market participants appear convinced a shift away from the current environment in the near future (i.e. a increase in interest rates) seems unlikely.
So what does it all mean?
First and foremost, one of the most important economic numbers to watch in the near future is the jobs report due on July 8, 2016. Unless a very healthy 200k+ jobs were created over the last month, it would seems reasonable to expect that the US Federal Reserve will stay their hand during the July meeting.
That could mean the “bad news is good news” cycle could still have legs at least through late summer/early fall because the next meeting is not until September.
One other number to watch going forward is the release of China’s updated foreign currency reserves, which are also due in the second week of July. The market has been carefully monitoring that vast Asian horde to make sure it doesn’t dip below $2 trillion as China is forced to defends its currency from a rapid (i.e. possibly destabilizing) devaluation.
Lastly, let’s not forget about oil, which has been leading the market for quite some time now. If crude and gasoline inventories are still being drawn down through July and into August then oil prices should hold the $45-50 range. Another reason to think the status quo isn’t going anywhere.
Obviously, new developments could derail the above scenario and catalyze an abrupt correction - but that’s a risk on any given day.
In my opinion, the fact that “Brexit” has failed to materialize as a “black swan-like domino” (as some described it) is positive reinforcement to stick with what’s been working.
Have you adjusted your portfolio or approach based on “Brexit” hype? Leave your comments below or reach out with any specific questions at firstname.lastname@example.org.
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Sage Anderson has an extensive background trading equity derivatives and managing volatility-based portfolios. He has traded hundreds of thousands of contracts across the spectrum of industries in the single-stock universe.