The sell-off in the financial markets in the beginning of this year opened up a seemingly endless series of surprising events so far, namely the Japanese negative interest rate policy, the European Central Bank’s program to purchase corporate bonds, the not-so-clear Fed’s path towards normalization and the unexpected result of the British referendum.
While in the first quarter, the main risk factors were concern for slowing global growth and many central banks’ loose monetary policies, the main event in the second quarter of the year occurred during the last two weeks of June. More specifically, on the evening of June 23rd, the citizens of the United Kingdom decided, by a narrow margin, to no longer be a part of the European Union, ending a roughly four decades long economic relationship. Global financial markets sold off due to the considerable uncertainty this separation could cause in trade, banking, travel and therefore, in economic growth.
The British pound lost nearly 10% of its value in the subsequent two trading days, touching a three decades low of 1.30. The expected risk-off reaction and the flight to safety resulted in a significant rally in global bond prices that sent yields plunging. Safe haven currencies such as the USD and Japanese Yen, benefitted handsomely relative to their peers. Even though the Federal Reserve did move rates higher earlier this year, the US 10 Year Treasury yield touched 1.40% during the last week of June, a level last seen in 2012. Japanese and German yields turned increasingly more negative!
With interest rates in the developed world moving lower, assets such as gold performed quite well rallying nearly 25% for the six-month period ending June 30th, 2016. Oil prices moved gradually higher to the tune of about 15%. U.S. High Grade Corporate Bonds returned about 7.5%, while U.S. High Yield bonds returned nearly 10% during the same period. The S&P 500 ended up modestly after the initial shock of the British referendum.
Given the uncertainty of Brexit and barring a substantial growth in jobs and hourly wages in the United States, it seems unlikely that the Federal Reserve will tighten further, even with US GDP numbers for Q1 being revised upwards from 0.8% to 1.1%. Moreover, the financial markets still seem confused as to how exactly assets should be priced in the aftermath of the referendum. We continue to closely monitor other events that we deem as key risk factors, namely the Chinese hard (or soft) landing and the coming U.S. elections. In the third quarter, we anticipate that uncertainty about the political landscape in the United Kingdom and its resultant approach to Brexit negotiations will contribute to further volatility as investors try to additionally monitor the potential outcome of the American election. We strongly believe that investors will be well served by remaining patient and undertaking a long term and tactical asset allocation approach to their portfolios.