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After Brexit, Investors Choose Exit

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RANDY FREDERICK: Hello and welcome to this special edition of the Schwab Market Snapshot. It’s June 24 and I’m Randy Frederick.

Well, on Thursday, June 23, Britain shocked the financial markets around the world by voting to leave the European Union. The so-called “Brexit” referendum passed. So, today, I’m speaking with Liz Ann Sonders, Schwab’s chief investment strategist, to get her perspective on this historic event and what it might mean for investors in the coming months. Welcome, Liz Ann.

LIZ ANN SONDERS: Thanks, Randy. Sorry, it’s been such a rough day.

RANDY: It’s been a rough one. So, Liz Ann, equity markets and interest rates have plunged. Volatility has spiked to levels that we haven’t seen since we had the market correction at the beginning of this year.

And perhaps even more surprising is that the collective wisdom of the marketplace, which is often so reliable, got it completely wrong this time. Equities rallied sharply the day before the vote—presumably on the expectations that it would be defeated—and yet the referendum passed. So what happened?

LIZ ANN: So you’re right. I think the markets did have it wrong. I think what the market was probably mostly keying off of was a lot of the betting markets that—at least until this vote—had been relatively accurate on every variety of market driver. So I think at the time there was a correct leaning toward what that data was telling you. Now, I think there’s a lot of skepticism, rightly so, about the validity of the betting markets, as we learned last night.

RANDY: Well, now, we’ve seen unexpected shocks like this in the past. I mean, the Japanese earthquake and nuclear accident in 2011. The fiscal cliff, which was also in 2011. And even the European debt crisis of 2012, just to name a few. So how does this particular shock compare to those two? And can we expect a similar outcome?

LIZ ANN: So at the close today the market was down about 3½%, at least on the S&P 500. And those three examples you had open days when the problem was announced between negative 3 and negative 6%. And what you find—at least using those three periods as a proxy—is it didn’t mark the end of the decline, it wasn’t just a one-day watershed event.

You, in those three cases, had between 10 and 15% more to go on the downside. But within about three to four months, you had fully recovered all of the losses. Now, that’s no perfect guide for what’s going to happen this time, but it does show you—and you can go back to the late 1990s and look at the Asian currency crisis, the Russian debt default—and it wasn’t much further you had to go down either in magnitude or duration before you started that recovery. So it could be the same this time.

RANDY: So it sounds like it may not be over just yet. Well, now, looking at the futures markets today, I noticed that not only has the probability of a rate hike in July, September and even November dropped all the way to zero. But now the futures markets are even pricing in about a 10% probability of a rate cut this year. So could this event actually cause the Fed to completely reverse its course on its plan to hike rates?

LIZ ANN: We doubt it at this point. We do think probably the best bet at this stage is to assume no additional rate hike this year. And that is a change from before the Brexit vote. But to expect that the next move by the Fed would be an actual cut to reverse the hike in December, I think that’s a bit of a stretch.

Remember, there are so many other things that the Fed can do. They can bring back some sort of quantitative easing they can provide through other liquidity facilities. And our guess is that if they felt they needed to do something—aside from what other central banks are doing, particularly the Bank of England, and possibly the European Central Bank—is they would maybe opt for one of those measures, as opposed to reversing the rate hike. So we would put the chances of a rate cut at something quite a bit lower than even 10%.

RANDY: OK. Well, now, given the rally in the U.S. Treasuries today, it seems like global investors are targeting the U.S. as a safe haven. And that’s also driven the dollar higher. So what are the implications for U.S. investors of a higher dollar and lower interest rates?

LIZ ANN: Yes, so it’s driven the dollar higher. It’s driven Treasury yields lower. So there has been this flight to safety—which we have been a safe haven in terms of our Treasuries and our currency for some time.

But we had had a bit of reprieve as it relates to the dollar. Where some of the excess increase in the dollar that we had seen into last year had started to ease back—the dollar had settled down. That was starting to improve prospects through the manufacturing sector because a weaker dollar tends to mean stronger export side of our economy.

The strong dollar, which also was tied to weaker commodity prices, is what, in particular, really hurt earnings growth. So the fact that we’ve seen a rebound in commodity prices—the settling down of the dollar—that started to improve earnings expectations. So one day doesn’t a trend yet make. But, if the dollar continues this move higher that started today, I think we’re likely to see some ratcheting down of expectations for earnings. And may also cause some problems again for what had been a kind of nascent recovery in the manufacturing sector.

RANDY: So it sounds to me like investors have a lot of things to think about. Thank you, Liz Ann, for that much needed clarity.

If you want to get more information—I know these are troubling times—please go to the website and you can read more of Liz Ann’s commentary in the Investing Insight section of And of course, you can follow Liz Ann on Twitter @LizAnnSonders, and you can follow me on Twitter @RandyAFrederick. We’ll be back again. Until next time, invest wisely. Own your tomorrow.

Important Disclosures

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