Market Update

• Britain leaves, stocks plummet. In a surprise move, the United Kingdom has voted to leave the European Union. Global markets are awash in red this morning, exacerbated by the last few days’ risk-on posture as a “remain” vote became viewed as consensus. After touching the 1.50 level against the dollar after yesterday’s close, the pound is now below 1.4 and briefly made a 30-year low. Overnight, Japan’s Nikkei Index was among the worst hit, closing down 7.9%, while in afternoon trading the German DAX is down more than 7%, France’s CAC is down more than 8%,the U.K’s FTSE is lower by approximately 4%, and Spain’s IBEX down more than 12%. Safe-haven assets are rallying as expected, with theyield on the 10-year note down to 1.53%, and COMEX gold up 5%. WTI crude oil is falling sharply and below $48.00, while the dollar index is up over 2.5%.

Macro View

• U.K. surprises markets, votes for Brexit. The U.K. voted to leave the EU in a very close vote yesterday, leading to Prime Minister David Cameron’s resignation and sending markets fleeing to safe havens amid the political uncertainty. The U.K. and EU will work over the next several years to determine the terms of the U.K.’s economic separation from the EU, essentially beginning the reversal of many decades of integration in the region. The political uncertainty, related impact of tightening financial conditions, and impact on U.K. trade are collectively causing investors and markets to price in greater odds of recession in the U.K. and Europe. The market’s extreme reaction reflects partly an unwinding of “remain” trades over the last week or so that were observable, in particular, in strength in European stocks and global financials.

• We believe U.S. economic impact from Brexit will be manageable. After the U.K. vote to the leave the EU, the odds of a recession in the U.S. have moved higher, but are still well below 50% in our view. Tighter financial conditions and a stronger dollar may be a slight drag on our exports. And lower commodity prices, market volatility, and lower interest rates may have some negative impact on corporate profits. But the U.S. economy is very resilient, and the direct impact of economic conditions in the U.K. and EU may be limited.

• Not another Lehman moment. While Brexit was unexpected and is likely to cause some near-term and perhaps even some longer-lasting financial market volatility, we do not believe Brexit will turn into another Lehman Brothers-type event. The U.S. economy, banking system, and consumers are in far better shape today than in 2008.

• We reiterate our 2016 equity market forecast.* We continue to expect mid-single-digit returns for the S&P 500 in 2016, driven by better U.S. economic growth and an earnings rebound in the second half of the year.

• Fed rate hike turns into rate cut probability. Futures show a small (15%) chance of a rate cut at one of the Federal Reserve Bank (Fed) meetings over the next few months and a rate hike has been priced out by the end of 2016. This morning the Fed already announced it is monitoring markets carefully and ready to provide unlimited U.S. dollar liquidity via existing swap lines.

• Treasury yields closer to record lows on flight to safety. The 10-year Treasury yield fell nearly 0.20% in early trading but is now off the overnight low yield of 1.49%. High-quality bond prices broadly are higher but are unlikely to match the pace of Treasury gains. The all-time low on the 10-year Treasury yield is 1.39%, reached in July 2012, and remains within striking distance. The 2-year Treasury yield, at 0.6%, is at its lowest level since October 2015 (and not far from the overnight borrowing rate), just prior to moving higher in anticipation of Fed rate hikes. Lower-rated bonds, such as high-yield bonds, are weaker as is typical during such episodes.

• Bigger bond moves occurring in Europe. The 10-year German yield is down to a record low of -0.08%, with the U.K. 10-year leading the way down -0.25%. Peripheral European government bond markets (Spain, Italy, Portugal, Greece) are weaker, but movements are slightly more subdued compared to those at the peak of the European debt crisis in 2011 and 2012.

• Banks pass tough stress tests. The Fed announced the first round of results from its stress tests last night and all 33 banks passed. Collectively, despite tougher scenarios, the banks maintained higher capital levels under stress than last year. This result is good news and validates the improved capital positions of the banks since the financial crisis, but will be overwhelmed by the extreme market volatility today following the U.K.’s surprising decision to leave the EU. Next week (June 29), the Fed will announce the results of its review of the banks’ plans to return capital to shareholders (dividends and share buybacks). In light of the Brexit vote, we would suggest caution toward financials given tightening financial conditions and low interest rates (and related flat yield curve).

Historically since WWII, the average annual gain on stocks has been 7 – 9%.  Thus, our forecast is in-line with average stock market growth. We forecast a mid-single digit gain, including dividends, for U.S. stocks in 2016 as measured by the S&P 500. This gain is derived from earnings per share (EPS) for S&P 500 companies assuming mid-to-high-single-digit earnings gains, and a largely stable price-to-earnings ratio. Earnings gains are supported by our expectation of improved global economic growth and stable profit margins in 2016.

Monitoring the Week Ahead

Friday

• Durable Goods Orders and Shipments (May)
• Germany: Ifo (Jun)

Click Here for our detailed Weekly Economic Calendar

 

Important Disclosures

Past performance is no guarantee of future results.

The economic forecasts set forth in the presentation may not develop as predicted.

The opinions voiced in this material are for general information only and are not intended to provide or be construed as providing specific investment advice or recommendations for any individual security. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly.

Stock investing involves risk including loss of principal.

Investing in foreign and emerging markets securities involves special additional risks. These risks include, but are not limited to, currency risk, political risk, and risk associated with varying accounting standards. Investing in emerging markets may accentuate these risks.

Treasury inflation-protected securities (TIPS) help eliminate inflation risk to your portfolio, as the principal is adjusted semiannually for inflation based on the Consumer Price Index (CPI)—while providing a real rate of return guaranteed by the U.S. government. However, a few things you need to be aware of is that the CPI might not accurately match the general inflation rate; so the principal balance on TIPS may not keep pace with the actual rate of inflation. The real interest yields on TIPS may rise, especially if there is a sharp spike in interest rates. If so, the rate of return on TIPS could lag behind other types of inflation-protected securities, like floating rate notes and T-bills. TIPs do not pay the inflation-adjusted balance until maturity, and the accrued principal on TIPS could decline, if there is deflation.

Bank loans are loans issued by below investment-grade companies for short-term funding purposes with higher yield than short-term debt and involve risk.

Because of its narrow focus, sector investing will be subject to greater volatility than investing more broadly across many sectors and companies.

Commodity-linked investments may be more volatile and less liquid than the underlying instruments or measures, and their value may be affected by the performance of the overall commodities baskets as well as weather, disease, and regulatory developments.

Government bonds and Treasury bills are guaranteed by the U.S. government as to the timely payment of principal and interest and, if held to maturity, offer a fixed rate of return and fixed principal value. However, the value of fund shares is not guaranteed and will fluctuate.

Investing in foreign and emerging markets debt securities involves special additional risks. These risks include, but are not limited to, currency risk, geopolitical and regulatory risk, and risk associated with varying settlement standards.

High-yield/junk bonds are not investment-grade securities, involve substantial risks, and generally should be part of the diversified portfolio of sophisticated investors.

Municipal bonds are subject to availability, price, and to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rate rise. Interest income may be subject to the alternative minimum tax. Federally tax-free but other state and local taxes may apply.

Investing in real estate/REITs involves special risks such as potential illiquidity and may not be suitable for all investors. There is no assurance that the investment objectives of this program will be attained.

Currency risk is a form of risk that arises from the change in price of one currency against another. Whenever investors or companies have assets or business operations across national borders, they face currency risk if their positions are not hedged.

Technical Analysis is a methodology for evaluating securities based on statistics generated by market activity, such as past prices, volume and momentum, and is not intended to be used as the sole mechanism for trading decisions. Technical analysts do not attempt to measure a security’s intrinsic value, but instead use charts and other tools to identify patterns and trends. Technical analysis carries inherent risk, chief amongst which is that past performance is not indicative of future results. Technical Analysis should be used in conjunction with Fundamental Analysis within the decision making process and shall include but not be limited to the following considerations: investment thesis, suitability, expected time horizon, and operational factors, such as trading costs are examples.

This research material has been prepared by LPL Financial LLC.

To the extent you are receiving investment advice from a separately registered independent investment advisor, please note that LPL Financial LLC is not an affiliate of and makes no representation with respect to such entity.

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