What the asset classes are telling us about BREXIT one week later

One week after BREXIT the markets are sending clear price signals on what investor think. It may not be exactly what anyone would have expected and the signals differ based on the market. Someone is going to be wrong and the odd market is UK equities.

• Bonds - The signal is clear. There has been a flight to safety in fixed income mixed with expectations of an economic slowdown and easing by the Bank of England. The strong trend  made this a trade that most benefitted investors. The fear of uncertainty crowd was rewarded.
• Currencies - The impact on sterling was consistent with bonds, poor growth tied with central bank easing as a stop-gap. However, the market was caught leaning to remain before the vote and was surprised after the results. There has been little positive bounce since the vote.
• Equities - Here the story is more complex. The FTSE 100 actually reversed the loses from BREXIT. If you fell asleep and just saw the end of month levels versus the pre-vote levels, you would assume that the vote was to remain. 

The equity market as measured by the FTSE 100 index is out of step with bonds and currency markets. It seems that bonds and currency traders have priced in continued uncertainty with a negative bias to future UK economic growth.

Market price signals - Long-term bond trends strengthen

Managed futures trend-following was winner in June for have large bond exposures. The trends have been strong, unambiguous, and showing no signs of decelerating. A review of trends across all major market sectors shows strong up moves across many markets. We use a combination of three moving averages )short/intermediate/long-term) to determine the sector direction.

Stock indices are mixed but last week's trend are pointing to an up trend; nevertheless, long-term trends are flat. Bonds and rates are showing strong rallies around the globe. Precious metals are moving higher as well as base metals which seems surprising given the bond moves. Energies are mixed with the exception of natural gas and commodities are headed lower except for those markets whose supply if focused on Brazil. 

Given the strong performance in June and the clear potential for the continuation of trends, there is the opportunity for further gains from trend-following. 

Things that keep me up at night this week ...

The biggest surprise was not the decline after the BREXIT vote, but the rally in a still uncertain world. Uncertainty or ambiguity should lead to more risk avoiding behavior yet risky markets bounced back last week. Conflicting signals on how BREXIT will be resolved and politicians that have been trying to score points for their views leads to a world that is more uncertain.

Nevertheless, there are other issues that will keep me up at night. The biggest issue is still growing leverage with non-financial companies and negative rates. Higher leverage will increase risks when there is a downturn. These are the seeds for future problems.

Asset class performance for June - Still a bond world

Take-away all of the crazy market behavior surrounding BREXIT and you are left with investment performance that centered around falling interest rates for June. This was a continuation of the main story for 2016. Given the June market uncertainty, this should not be surprising, but a look at where we are at the end of the first half of the year is surprising.

Let's go back to the end of last year and remember what many were thinking. The Fed raised rates in December and made clear that this would the first of a number of up moves. The US economy was looking stronger. While Europe was still under pressure, there was the general belief that the ECB could nudge growth upwards. There were concerns about Chinese credit quality, but BREXIT was not a concern. Credit was looking dangerous given the low price of oil albeit there was some talk of a price bottom. There were concerns about equities, but not because of global uncertainty or dislocations in politics. Many pundits on asset allocation got it wrong.

The clear winner was holding long bonds; long duration in the US, the EU, or anywhere in the world. The biggest winner was commodities after a horrible year in 2015. Diversified global equities did poorly but credit showed strong gains even with higher bankruptcies. 

Asset allocation forecasts for the first half of the year, in general, have proved wrong. The only winners were those investors who followed the price action in trends.