What is Behind Post-Brexit Market Gains?

By Jonathan Scheid
 19-Aug-1612-Aug-16Weekly% ChangeYTD% Change12 month %Change
S&P 500 Index 2,183.872,184.05-0.01%6.85%10.81%
Dow Jones Industrial Average 18,552.5718,576.47-0.13%6.47%12.71%
Nasdaq Composite 5,238.35,232.890.10%4.61%11.31%
Russell 2000 1,236.771,229.820.57%8.88%6.91%
MSCI EAFE (Intl.) 1,669.761,710.73-0.64%-0.96%-6.16%
10 Year U. S. Treasury Yield 1.56%1.51%3.31%NANA
30 year U.S. Treasury Yield 2.26%2.23%1.35%NANA

Global stock markets experienced a strong rally following the United Kingdom referendum vote. While the initial market reaction to the news of the U.K. voting to leave the European Union was quick selling, investors just as quickly changed their tune. U.S. stocks, international stocks and emerging market stocks have all been moving up over the two months following the vote.

Additionally, volatility has been very low following this market shock. Believe it or not, we’ve gone over 30 trading days in the U.S. without the S&P 500 Index moving up or down more than 1%. We haven’t seen a streak this long since 2014 and there have only been 12 other times since 1992 that we have seen the S&P 500 trade within this narrow range for 30 or more days (Source: Schaeffer’s Investment Research). In a period of time when investors assumed volatility would be high, quite the opposite occurred.

One theory that we have seen in the media about this rally and the low volatility stems from the relationship between bonds and stocks. Following the U.K. vote, interest rates on bonds went lower and they have stayed low. In many cases, the income that investors receive from stocks in the form of dividends is now higher than the interest rate earned from bonds. For example, on Friday, August 19, the S&P 500 Index had a dividend yield of 2.03% and the 10-year U.S. Treasury bond was yielding 1.56% (source: Morgan Stanley).

Putting risk aside, an investor looking for income would earn more from holding the S&P 500 (i.e., stocks) than the 10-year U.S. Treasury (i.e., bonds). They call it a “search for yield” as investors start to purchase more stock positions for the income. This additional buying sends stock prices higher. Further, some have theorized that this search for yield is making stocks more vulnerable to market shocks. The thinking goes, if interest rates on bonds start to rise, all the recent money that went into stocks looking for dividends will quickly leave to go get bonds again and that will send stocks lower.

While we believe there is some truth to the search for yield claim, we don’t believe that it is the main reason stocks are advancing. We believe, and we feel the data supports, that companies are doing better and the economy is doing better. U.S. companies have struggled to increase profits over the last year. According to FactSet, we’ve experienced five straight quarters of year-over-year corporate earnings declines. Fortunately, the magnitude of the declines has slowed and earnings are expected to start advancing again in the third or fourth quarter this year.

When it comes to the economy, there are many bright spots to point to. In the U.S., our economy continues to produce jobs, inflation is low, real estate is strong and most forward looking indicators are positive. Globally, economic data is getting better as well. According to data compiled by Deutsche Bank, economic data has been beating estimates (measured by an index called the Global Macro Surprise Index) for the last couple of months and has been trending up since February. Additionally, they found that the correlation between this global macro surprise index and the stock market, is at a 10-year high. This means that the improving economic data is helping fuel the global stock market advance. Improving companies and economies have historically been good for stock investors.

The views and opinions contained herein are those of Bellatore Financial, Inc. and have been researched and analyzed by Jonathan Scheid, Chief Investment Officer, Bellatore Financial, Inc.

All Indices are unmanaged and are not available for direct investment by the public. Past performance is not indicative of future results. The NASDAQ Composite Index measures the performance of all issues listed in the NASDAQ Stock Market, except for rights, warrants, units, and convertible debentures. The S&P 500 is based on the average performance of the 500 industrial stocks monitored by Standard & Poor’s. The Dow Jones is computed by summing the prices of the stocks of 30 large companies. The Morgan Stanley Capital International (MSCI) Europe, Australia and Far East (EAFE) Index is a broad-based index composed of non U.S. stocks traded on the major exchanges around the globe. The Wilshire 5000 Total Market Index represents the broadest index for the U.S. equity market, measuring the performance of all U.S. headquartered equity securities with readily available price data. Capital Allocation & Management is a managed money program offered through Bellatore Financial, Inc. 15.003.c.1.15