Friday June 24 Daily Market Primer Brexit Edition

It was a day for the history books Thursday as the UK voted with their feat to leave the European Union.  The Brexit vote reminds us of the inherent unpredictability of political events, economics, and markets,  when even in as closely watched an event as this one, the polls, pundits, and odds makers all got it wrong.

Markets rallied in the US yesterday, but it doesn’t matter as the US gains were quickly overtaken by events triggered by the surprise UK vote to leave the European Union.  Global risk markets had a priced in a remain win as probabilities in the polls and the UK betting sites had converged over the last few days.  The first to go was the pound, which fell 10% against the dollar and started to drop the minute “leave” edged ahead in the count.   Asian equities were trading and fell about 3%, and European and US stock futures let go as investors sold stocks and bought treasuries and yen.  Japanese, French, Italian, Spanish, and German stocks got hit the hardest, down 7 to 12%.  Ironically the FTSE 100 is only down 4%.  The US 10 year yield is back down to 1.53% and the VIX jumped 40%.  US stock futures are pointing to -3.5% opening, or down about 80 S&P points (E-Mini S&P500, below).   Note that this is an improvement from when I went to bed last night, when the S&P futures were down 105 points.

British PM David Cameron, the architect of the referendum, resigned and will step down as the leader of the Tory (Conservative) party and will leave office by October.  So we can add another important election to the summer election season.  Central banks are promising to make liquidity available to ease market stress as necessary.

	LAST	CHANGE	% CHG
DJIA	18011.07	230.24	1.29%
Nasdaq	4910.04	76.72	1.59%
S&P 500	2113.32	27.87	1.34%
Russell 2000	1172.22	23.25	2.02%
Global Dow	2294.54	-88.81	-3.73%
Japan: Nikkei 225	14952.02	-1286.33	-7.92%
Stoxx Europe 600	320.79	-25.55	-7.38%
UK: FTSE 100	6070.23	-267.87	-4.23%
CBOE Volatility	24.14	6.89	39.94%
Australia: S&P/ASX 200	5113.2	-167.5	-3.17%
China: Shanghai Composite	2854.29	-37.67	-1.30%
Hong Kong: Hang Seng	20259.13	-609.21	-2.92%
India: S&P BSE Sensex	26397.71	-604.51	-2.24%
France: CAC 40	4077.7	-388.2	-8.69%
Germany: DAX	9516.22	-740.81	-7.22%
Italy: FTSE MIB	15992.04	-1974.13	-10.99%
Spain: IBEX 35	7760.2	-1125.1	-12.39%
U.S. 3 Month	0.248	-1/32
U.S. 2 Year	0.609	10/32
U.S. 5 Year	1.029	1 3/32
U.S. 10 Year	1.536	1 29/32
U.S. 30 Year	2.393	3.8/32
Germany 2 Year	-0.641	6/32
Germany 10 Year	-0.075	1 22/32
Italy 2 Year	0.058	-5/32
Italy 10 Year	1.471	1 19/32
Japan 2 Year	-0.281	3/32
Japan 10 Year	-0.196	19/32
Spain 2 Year	0.046	-3/32
Spain 10 Year	1.619	-1 11/32
U.K. 2 Year	0.273	17/32
U.K. 10 Year	1.072	2 23/32
Crude Oil	47.82	-2.29	-4.57%
Brent Crude	49.1	-2.51	-4.86%
Natural Gas	2.721	-0.023	-0.84%
Gasoline	1.5447	-0.0669	-4.15%
Gold	1328.8	65.7	5.20%
Silver	18.005	0.595	3.42%
Corn	379.25	-13.25	-3.38%
Wheat	458.8	-7	-1.50%
E-mini DJIA	17407	-508	-2.84%
E-mini S&P 500	2032.5	-73.25	-3.48%
Reuters-Jefferies CRB	188.974	-4.551	-2.35%
S&P GSCI	369.33	-11.38	-2.96%
Euro (EUR/USD)	1.1074	-0.0311	-2.73%
Yen (USD/JPY)	102.5	-3.65	-3.44%
Australia $ (AUD/USD)	0.7431	-0.0183	-2.40%
Canada $ (USD/CAD)	1.3002	0.0236	1.85%
Euro/Yen (EUR/JPY)	113.49	-7.35	-6.08%
Euro/Swiss Franc (EUR/CHF)	1.0811	-0.0104	-0.95%
Mexico Peso (USD/MXN)	18.8494	0.6197	3.40%
New Zealand $ (NZD/USD)	0.7114	-0.0137	-1.89%
Pound (GBP/USD)	1.3723	-0.1151	-7.74%
Pound/Euro (GBP/EUR)	1.2393	-0.0671	-5.14%
Swedish Krona (USD/SEK)	8.5255	0.3629	4.45%
Swiss Franc (USD/CHF)	0.9761	0.0176	1.84%
Chinese Yuan (USD/CNY)	6.6247	0.0443	0.67%
WSJ Dollar Index	86.78	1.63	1.92%

British PM David Cameron, the architect of the referendum, resigned and will step down as the leader of the Tory (Conservative) party and will leave office by October.  So we can add another important election to the summer election season.

Here are Jim McDonald’s morning comments:

Asset allocation thoughts:

·         The overnight vote results showing a win by the "Leave" campaign are a major surprise to the markets and are roiling asset prices. The surprise is exacerbated by the momentum the "Remain" campaign seemed to be showing in the week before the vote. In fact, today's significant sell-off is more than erasing the gains made since mid-June.

·         The economic and investment implications of Britain's vote are complex and in many ways still to be determined. We will be assessing these implications in coming days and weeks, and most importantly, comparing them with price developments in asset markets.  A move from our moderate overweight to risk assets will be justified if we feel asset prices have materially mispriced the fundamental outlook over the next twelve-eighteen months.  On a short-term basis, we wouldn't be selling into the weakness as European stocks are already down more than 7% today and the relative safe-haven US market is indicated down nearly 4%. 

·         The direct economic impact of the U.K. Leaving the EU is likely not material to the global economy. The greater risk comes from the potential tightening of financial conditions and discounting if further EU fracturing. As we advance our thinking on these developments in coming days and weeks, we promptly communicate those thoughts.  

As we talk to clients today, be confident and reassuring.   This is not a Lehman moment.  Here are a few important points to emphasize:

·         We have managed portfolios through volatile times before, recently including 2008, last summer, and January and February of this year.  This is familiar territory for us and we know what to do.

·         We avoid making asset allocation changes during times of market stress.  Markets can reverse quickly and unpredictably.  If changes to portfolios are warranted, Northern’s Investment Policy Committee will recommend changes in a measured, considered way as we have more information and clarity.

·         Volatility and “unexpected” events are expected, are part of the natural cyclicality of markets, and happen fairly regularly.

·         We have taken measures to provide Bond Runways for many clients to provide comfort in exactly these types of markets.  Many of our clients have excess sufficiency and long time frames.   Clients with allocations to private assets have shielded part of their portfolios from this volatility.

Please quickly escalate any difficult client situations to your SIO’s, MDs, or to me.

The US market opens in 15 minutes.  Here’s the news:

Brexit wins out

After months of waiting, now the real uncertainty begins. The U.K.'s decided it wants to leave the European Union and with no clear blueprint for that process, volatility ruled. The pound swung from its highest to its lowest level in six months during the vote count before weakening to as low as 1.32 dollars as it became clear that Brexit had edged it, in defiance of both the polls and Prime Minister David Cameron, who announced he is stepping down in the wake of the vote. The FTSE 100 fell 8.7 percent at the open, yet on account of exchange rate effects/currency weakness it still managed to be the day’s best performing of the largest EU equity benchmarks, as of 6 a.m. in New York.

Historic Exit
Britons voted to leave the European Union in a startling rebuke that rattled financial markets and threatens to spark political turmoil in the U.K. and weaken a continent already strained by multiple crises. With all voting areas counted, Leave beat Remain 51.9% to 48.1% early Friday, severing the U.K.’s ties with the EU after 43 years. The vote instantly reshaped the political legacy of U.K. Prime Minister David Cameron, who led the “Remain” effort and said this morning he will resign. Boris Johnson, the former London mayor who campaigned for “Brexit,” scored a major victory. He hailed the result as a “glorious opportunity” for a fresh start for Britain in the world and said the EU had outlived its historic mission. He is now a leading candidate to succeed Mr. Cameron. The market moves as the result emerged were enormous. Sterling went from a high for the year to its lowest level since 1985. It was a brutal drubbing for investors who had stacked up bets that the U.K. would choose to stay. Nothing was spared from the tumult.

Central banks at the ready

Liquidity will be provided as needed, was the mantra of central bankers reacting to the vote — and some have already leapt into action. The Swiss National Bank intervened to stabilize the franc, while the Bank of Japan stated its readiness to act to hold down the yen, which appreciated below 100 to the dollar for the first time in over a year. BOE Governor Mark Carney said he's ready to pump 250 billion pounds ($345 billion) into the financial system, as bets on a July interest rate cut climb to 50 percent. The European Central Bank also said it's prepared to provide liquidity as the bloc's currency dropped, by 5.30 a.m. New York time, to 1.11 against the dollar.

Flight to havens

The yen was the only G10 currency to strengthen against the U.S. dollar as of 4.46 a.m. ET, rising 3.12 percent as investors fled riskier assets. Amid a stampede to safer assets gold posted its biggest one-day gain since the global financial crisis of 2008 and U.S. Treasuries surged, with benchmark yields falling by as many as 34 basis points, their biggest drop in seven years. Brent crude futures slumped as much as 6.6 percent, as bets of a global recession picked up.

What Brexit means for the Fed

As for the Federal Reserve — all that talk of a June rate hike now seems very far away. "I’m overwhelmed with client questions about the impact on the U.S .and the Fed," wrote Deutsche Bank AG economist Torsten Slok in a note to clients. UBS withdrew its forecast for a 25 basis point hike in September, however it still sees a hike in December.

Who's Nexit?

Euroskeptic politicians across the continent have already seized the chance to demand their own referendums, in the U.K.'s mold. With Spain holding elections this Sunday and a debate on constitutional reform approaching in Italy fast approaching, there are ample opportunities for the secessionist bug to pick up steam. Most notably, Scotland's First Minister Nicola Sturgeon said she will explore all options to secure Scotland's membership in the EU, including a possible second referendum on Scottish independence. 

David Cameron is resigning. "I will do everything I can as prime minister to steady the ship over the coming weeks and months, but I do not think it would be right for me to try to be the captain that steers our country to its next destination," Cameron said in an emotional speech outside 10 Downing Street. The prime minister promised the referendum back in 2013, backing the Remain campaign. "In my view we should aim to have a new prime minister in place by the start of the Conservative Party conference in October," Cameron said.
Global markets are in shambles. US futures are sharply lower, with S&P 500 futures down 74 points (3.53%) and Dow futures down 497 points (2.79%). Stocks rallied into the market close on Thursday as traders bet that Britain would vote to stay. European stocks are also in chaos: the FTSE 100 is down 4.9%, and the Euro Stoxx is down 8.4% to its lowest level since February. Japan's Nikkei tanked 7.9%, also to a February low. The flight from stocks is pumping Treasurys and gold. Gold is up 4.5%, or $57 an ounce, to $1,320.10, a two-year high. The yield on the 10-year Treasury note is down 22 basis points to 1.512%, not far from a record low.
The pound had its worst crash ever. The British currency had its biggest one-day drop on record, plunging more than 11.0% to a low as 1.3239 per dollar — a 30-year low. "Britain's shock vote to leave the EU has unleashed a wave of economic and political uncertainty that likely will drive the UK into recession," Samuel Tombs, the chief UK economist at Pantheon Macroeconomics, said in a note.
European central banks are stepping in. Bank of England Governor Mark Carney said the central bank could pump up to £250 billion ($345 billion) into the financial system to steer the economy through a "period of uncertainty and adjustment." He added that this could be accompanied by more volatility. The Swiss National Bank said it intervened in the foreign-exchange market and would remain active after the franc soared against the euro. Federal Reserve Chair Janet Yellen said in congressional testimony earlier this week that a Brexit vote could have "significant repercussions."
Donald Trump says Britons took their country back. The Republican presidential frontrunner, who is in Scotland to open a golf resort, said "they're angry over borders, they're angry over people coming into the country and taking over and nobody even knows who they are," according to the BBC. Analysts are opining on what this means for the US election in November. "If Britain can vote itself out of Europe, America can vote itself in for Trump," veteran Republican pollster Frank Luntz told Business Insider.
JPMorgan may rejig its European operation. In a memo to employees, CEO Jamie Dimon said "we may need to make changes to our European legal entity structure and the location of some roles." The bank plans to retain a "large presence" in Britain, Dimon said. Three weeks ago, Dimon said in a speech that JPMorgan could move an undisclosed number of its 16,000 UK-based workers to Europe if Britain votes for a Brexit.
The 33 biggest banks aced their stress tests. Results of the Federal Reserve's latest tests showed Thursday that the banks had sufficiently boosted their protections against a sharp economic downturn. The tests, conducted since 2009 and mandated by the Dodd-Frank Act since 2011, attempt to determine the safety of financial institutions with more than $50 billion in US-based assets.
Twilio surged 92% in its market debut. Twilio, which provides phone and messaging support services, priced at $15 a share and ended Thursday at $28.79, a 91.9% jump. It was this year's third and biggest initial public offering in tech.
In US economic data, May durable goods orders will be released at 8:30 a.m. ET. And the University of Michigan's preliminary consumer sentiment report for June is due at 10 a.m. ET.

New World Order
The U.K. and the EU now must navigate an unprecedented separation while trying to prevent political and economic dislocation. The vote isn’t legally binding, so Parliament must pass laws to make Britain’s exit a reality. For leaders in the EU, the vote raises fears of further disintegration and raises hopes for nationalist politicians in the Netherlands, France and elsewhere will likely seek to follow. European businesses must adjust to a new landscape, while the result is also expected to jolt the U.S. economy, likely rattling restive equity markets and driving up the value of the dollar and pushing down already low bond yields. The vote battered the pound, pushed down stocks in Asia and points to a day of turbulence across the world’s financial markets.

Split Court
A deadlocked Supreme Court on Thursday killed President Barack Obama’s plan to defer deportation and provide work authorization for millions of illegal immigrants, pushing the issue to the forefront of the 2016 election. Although the high court’s 4-4 vote established no new precedent, it effectively put an end in effect to Mr. Obama’s effort to extend his executive authority over immigration to the outer limit. The one-sentence ruling was the latest defeat for Mr. Obama in the courts, which recently have stymied some of his administration’s top policy goals. The outcome doesn’t require the administration to begin deportations of the affected immigrants, but it does halt the government’s plan to normalize their presence by granting them authorization to work. Also yesterday, a divided court upheld racial preferences in public-university admissions,

Hacked blockchain user launches $50M debate

Venture capital fund Decentralized Autonomous Organization has been hacked, with $50 million stolen, prompting debate on whether to tweak Ethereum, the blockchain it uses. "The governing individuals that created Ethereum are in a tough situation: Either they change the Ethereum blockchain to reverse the theft from the DAO and deal with questions of immutability or allow thieves to get away with their crime for the sanctity of the young blockchain," said Wedbush Securities analyst Gil Luria.

Bloomberg (23 Jun.) 

Asset managers are braced for redemptions.

Here are five markets charts to watch in the aftermath of the Brexit vote.

When Carney says "additional measures" analysts hear rate cuts.

Nationalist parties across Europe feel emboldened.

How currency traders reacted to the vote.

HSBC says get ready for stagflation in the U.K.

U.S.-Backed Forces Enter Key Syrian City Held by Islamic State

U.S. Oil Companies Crank Up Production in Gulf of Mexico

Fed Stress Tests: All Big Banks Clear Bar for Capital Requirements

Turkey’s Rift With Moscow Frays Ties With Turkic Kin

There's so much to think about with regards to last night's Brexit vote and its implications, that it's hard to even know where to start. In the days ahead there will be a million takes about what it means for financial markets, globalization, politics, and much more. In the meantime, here are two very quick thoughts. The last time markets felt anything vaguely like this was in March 2011 in the immediate aftermath of the Japanese earthquake and the disaster at the Fukushima power plant. In the ensuing days, we saw major swings and stark air pockets as traders attempted to assess a chaotic, unknowable risk. As for the medium-term, one thing I'm interested in is whether the market turmoil we're seeing today accelerates similar "-xit" movements in other countries, or whether the U.K. will be seen as a cautionary tale. It's way too soon to know how all that evolves, but it's the crucial thing to watch.

Source: Bloomberg, BI, WSJ, CFAI Fin. Newsbrief