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Brexit Aftershock: When Will the Markets Calm Down?

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RANDY FREDERICK: Hello, and welcome to the Schwab Market Snapshot for June 27. I’m Randy Frederick.

Well, last week’s Brexit referendum shocked global financial markets. And now that the vote is over, everyone wants to know what happens next. So, today, I’m speaking with Jeffrey Kleintop, Schwab’s chief global investment strategist, because he always has his finger on the pulse of the global markets. Welcome back, Jeff.

JEFFREY KLEINTOP: Thanks. It’s great to be here, Randy.

RANDY: So, Jeff, I think most people probably know by now that the U.K. referendum to leave the European Union was passed last week. And it seems like almost everyone was caught off guard. There’s a lot of misinformation, a lot of conjecture and things like that going on—so can you tell us what are the immediate ramifications?

JEFF: Well, certainly, the initial shock of the unexpected outcome caused a sharp decline in stock markets around the world. And we believe it might take some time for the shock to fully work through the political, economic and financial markets in the U.K. and in Europe. But in terms of what happens next? Nothing.

Nothing really happens right away—which is both good and bad. Following the decision to exit, the U.K. needs to negotiate the terms of its withdrawal, which may not start until the fall, when the prime minister steps down. So there’s no sudden cutoff. But there’s also no clarity on what the eventual result of the negotiations may be. And that means that rather than a sudden but known impact, it leaves lingering uncertainty that can erode confidence and act as a drag on consumer spending and business investment—slowing the global economy and weighing on stocks.

RANDY: Well, Jeff, bank stocks it seems like have been one of the hardest hit for the last couple days. So it brings up the age-old question that has to be haunting all investors right now. And that is how monumental is this issue? Is this the type of an unprecedented event like the Lehman Brothers meltdown back in 2008?

JEFF: It’s the inevitable question whenever we get one of these pullbacks, “Is it Lehman?” No, I don’t think so. The declines in the stock market in the immediate aftermath of the referendum in the U.K. and Europe actually didn’t even get us all the way back to the lows of the year—which were back in February. It’s been kind of an orderly decline.

And even in the bond market, we haven’t seen money flowing out of the U.K. In fact, there’s been buying of U.K. debt. So no capital flight from the country, like you might expect. So no signs of panic or what you might expect from a financial catastrophe similar to the bankruptcy of Lehman Brothers back in 2008. That looks pretty unfounded for now.

Banks are often a weak spot whenever we get a shock to the system, but they’re much better off now than they were back in 2008. For example, in the U.S., banks now have about $2.3 trillion in excess reserves on their balance sheet. That’s up from zero in 2008. So they’re much better positioned. And the U.S. economy appears to be on much better footing than it was back then. The issues in Europe are much less likely to be that onerous on the American consumer versus the housing collapse that we saw in 2008.

RANDY: OK. Well, that makes sense. But if 2008 is not a fair comparison, are there any other events in the past to which we can draw a much closer parallel?

JEFF: Yes, it’s interesting. This economic cycle has been different than most. We haven’t just seen a steady growth rate in excesses like lending and housing and the like. Instead, we’ve seen a series of shocks that have kept growth and inflation in the markets in check.

After the shock of the earthquake—I’m reminded, back in Japan in 2011—stocks fell 16% as the Japanese economy fell into a recession. But, ultimately, stocks recovered about four months later.

The same thing was true in the U.S. In 2011, we had that debt ceiling debacle, that war over the debt ceiling, and that led to a downgrade of U.S. debt and a lot of uncertainty. Stocks fell about 14% but recovered after about three months.

And then again in 2012, in the European debt crisis, we saw about an 11% stock market decline, as a lot of fears about what was going to happen in Europe regarding the debt crisis. Ultimately, stocks came back in about three months, as well.

So there’s no two shocks that are the same. But we can draw some parallels, perhaps, to what we’ve seen in the past—initial, immediate reaction in the markets, followed by double-digit declines—but hopefully healing over the course of three or four months as markets come back.

RANDY: So it seems pretty likely that no matter what happens, this issue is not going to go away any time soon. So that kind of brings me to my last two questions. And that is, what should investors be focusing on now? And, finally, what signs should we be looking for to tell us that the financial markets are calming down and things are stabilizing?

JEFF: Yeah, I’m hoping this is just another one of those shocks—right? And we can look at maybe a rough second half of the year, but maybe not problems going out into 2017 or 2018. Three things, I think. One, economic. Let’s look at the economic data and see if countries are able to capitalize on their weaker currencies by boosting exports offsetting maybe some of the domestic weakness.

So that’s one thing to watch. Two, is political. We’ve got a lot of votes coming up over the course of the next year or so—including big elections in France and Germany. Watching those polling results and the anti-establishment parties might give us a key as to how populism is shaping up in Europe.

And then, finally, on the currency side. The Japanese yen is always a good sign of flight to quality. It tends to rise during periods of stress. If that stabilizes, it might be a sign that the worst is over.

But, Randy, I think the best thing investors can do right now, if you’re a short-term trader—you probably have a little bit more downside here—you probably want to be defensively positioned. But over the longer term, investors may want to maintain their diversified asset allocations intended to weather just this type of volatility on the way to long-term goals.

RANDY: I think that’s some pretty good advice, Jeff. Thank you for your perspective.

Listen, if you have more questions, please call and talk to a Schwab financial professional. And you can, of course, read more of Jeff’s commentary—and he’s probably going to put a lot of it out in the next few days—on the International Investing section of Schwab.com. And, don’t forget, of course you can follow Jeff on Twitter @JeffreyKleintop, and you can always follow me on Twitter @RandyAFrederick. We will be back again. Until next time, invest wisely. Own your tomorrow.

Important Disclosures

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. Please note that this content was created as of the specific date indicated and reflects the author’s views as of that date. It will be kept solely for historical purposes, and the author’s opinions may change, without notice, in reaction to shifting economic, business, and other conditions.

Data contained herein from third party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed. Supporting documentation for any claims or statistical information is available upon request.

Past performance is no guarantee of future results and the opinions presented cannot be viewed as an indicator of future performance.

International investments are subject to additional risks such as currency fluctuation, geopolitical risk and the potential for illiquid markets. 

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