It has been a week since the Brexit vote, and the financial markets are backing off the initial reaction. This happens quite often when there is unexpected news. Investors tend to overreact.
In terms of the U.S. economy, it is hard to believe that it would be much affected by the Brexit leave vote. Obama can threaten to put the United Kingdom at the back of the queue, but the reality is that trade will continue. The only way it won’t continue is if Obama and company purposely block trade to punish the British voters.
Very few people saw the results of this vote coming. The polls were mostly wrong, the betting sites were wrong, and most of all, the financial markets were wrong.
Stock investors don’t like uncertainty. The “leave” vote was a repudiation of the status quo. Stock investors don’t want to deviate from the status quo, even if it is potentially good in the long run.
Even though stocks fell dramatically on the Friday right after the results, they have since mostly recovered. The interesting thing is that bonds and gold have not really reversed, as of right now.
Gold surged past $1,300 per ounce and it closed near $1,325 as of this writing. This is while the U.S. dollar has actually gained because of the weakness of the euro and the British pound.
What is sticking out even more to me than gold is the bond market. The 10-year yield is currently just below 1.5%. Since the initial surge in bonds, they have not given up their gains at this point.
Some of the foreign bonds are even crazier. The 10-year yield in Japan is -0.23%. That is a negative sign in front of that number.
The German 10-year yield has now gone negative as well. It was slightly above zero just before the Brexit vote.
So even though U.S. stocks seem to be recovering from the initial reaction, there is still a lot of clinging to safety.
In a time of fear, investors seek safety in different things. The three main things that come to mind are the U.S. dollar, bonds, and gold. The first two are safe havens in an environment of low price inflation. Gold tends to be more of a safe haven when inflation is running higher.
All three of these asset classes are holding up well right now. The U.S. dollar is doing well though because of the weakness of some of the other major currencies.
I’m not sure which one is going to win out. While I tend to favor gold in the long run, I think the bond investors may win this in the short run. Meanwhile, stock investors are likely clueless for the most part. I say this as a generality of the markets. Think about all of the 401k investors out there who blindly throw money in any fund they can find.
The bond market tends to be an accurate predictor of the state of the economy. The dropping of long-term yields is signaling a possible slowdown. An inverted yield curve is the classic indicator of a recession.
Just think about the 10-year yield in the United States. People are turning over their money to the government in order to get an interest rate of just 1.5% per year over 10 years. And this is with little idea of what the dollar will be worth 10 years from now when you would get your principal back.
In conclusion, I wouldn’t trust the stock market here. It may or may not go higher. But the bond market, if it holds, is telling us to watch out for something. The long-term yields aren’t low just because of Brexit. There is already weakness out there.