What a difference a couple of weeks make. It was just 21 days ago when the global markets were caught off sides as UK citizens voted to leave the European Union. The move was largely unexpected and as a result, global investors sold first and asked questions later, scrambling to understand how this might impact their investments. As we have seen over and over, the markets do not like surprises or uncertainty and the Brexit outcome created both. Over two trading sessions, the EuroStoxx 50 Index sold off nearly 16% (in US dollars) and the FTSE 100 Index fell over 13%. The S&P 500 Index was not immune to the selloff and declined over 5% in sympathy with the global markets. And then suddenly, stock markets came roaring back. The EuroStoxx and FTSE averages have retraced most of their Brexit declines and the S&P 500 has rallied to new all-time highs.
Finding opportunity in the middle of uncertainty
The initial knee-jerk selloff reaction to Brexit appears to have been wrong. That is, the worst-case scenarios of global trade grinding to a halt and another European recession won’t likely play out. Brexit’s direct impact to the US economy will be minimal. However, the event has and will influence our capital markets in more subtle ways through currencies and interest rates. The event served to exacerbate some dominant market trends.
For example, global markets will continue to favor US Treasury securities (and defensive dividend-paying stocks) because the US is seen as a safe haven in a troubled world and earning 1.4% on a 10 year Treasury bond is far better than losing money on an equivalent German sovereign bond. So whatever the Federal Reserve Bank presidents say, interest rates are likely to remain low for now. And the resulting strong dollar will help keep the lid on inflation.
For all of the above reasons, investors are looking for quality interest rate sensitive investments that still represent reasonable valuations. So where does an investor go to find value in this segment?
· Interest rate sensitive assets like REITs are a viable investment vehicle and still represent good value, whereas utilities and telecom stock multiples are trading at multi-year highs.
· Intermediate investment grade corporate bonds offer good yields and valuations, whereas floating rate and ultra-short maturity bonds will continue to under perform until rates begin to rise.
· Quality large cap blue chip growth companies that generate most of their revenues in the US and North America will be better positioned than companies with large European exposures.
Lighthouse has been building and managing our investment strategies for the past 24 months with a focus on quality large cap US investments that pay dividends. The only shift in our overall outlook as a result of the UK vote is that interest rates will remain lower for longer and the US dollar will stay elevated and could even appreciate further.