The Brexit Recovery

As the U.S. geared up for the 4th of July, investors around the world declared independence from Brexit worries.

Financial markets swung wildly in the wake of Brexit, the UK’s vote to secede from the EU. The result of the vote surprised many investors and spurred a flight to bonds and other “safe haven” investments, as investors expressed uncertainty over the implications of the decision and concern that it could disrupt the global economic recovery.

brexitrecovery_s&p500But following a two-day route in global equity markets, stocks rallied strongly amid speculation that policy makers may move to minimize the impact on global growth of the U.K.’s decision.

For the week ending July 1st, the S&P 500 was up 3.22%, while the S&P Global of developed and emerging markets around the globe gained 3.57%.

Positive economic data also helped alleviate some of investors’ anxiety. A report last Tuesday showed the U.S. economy in the first quarter expanded more than was previously reported, while consumer confidence increased in June for the first time in three months, according to a report from the New York-based Conference Board.

In the fixed-income markets, the yield on the 30-year Treasury bond fell to its lowest level since February 2015, pushing bond prices higher. Data showed a measure of inflation preferred by the Fed fell short of forecasts. Meanwhile, traders have cut back their bets for an interest rate hike by the Federal Reserve Board due to increased levels of uncertainty. They now see a less than 10% chance of a rate hike this year, and expect February 2018 to be the first month with at least even odds of a rate hike.

GAIN: Active Asset Allocation

Global equity markets processed the Brexit vote quickly, erasing the losses that occurred in the days following the outcome. Meanwhile, The CBOE Volatility Index (a key benchmark for gauging anticipated market volatility) returned to more normal levels, as did other measures of market stress.

However, interest rates in the U.S. did not rebound to the extent equities did, in part because investors now believe the Federal Reserve Board will not raise interest rates this year.

Horizon’s equity portfolios continue to strongly emphasize U.S. stocks over international shares. Our low exposure to international markets relative to peers has helped reduce volatility in the portfolios post-Brexit. Meanwhile, the fixed-income portfolios benefited from a rebound in corporate bonds that occurred as equity markets stabilized.

PROTECT: Risk Assist

Markets have now recovered most of the losses they suffered immediately post-Brexit and significantly reduced their outlook for continued volatility (the CBOE Volatility Index, or VIX, plummeted from 25 to 15 in just four days). Essentially, investors treated Brexit as a one-time re-pricing of assets which resulted in slightly lower global equity values, lower interest rates and a stronger U.S. dollar—but without a continuation of the “risk-off” tone seen immediately after the vote.

Real Spend’s approach to risk mitigation was beneficial in the days prior to and following Brexit, helping to limit losses and deliver stronger returns relative to the S&P Global for the week and the month of June. Our option positions helped the accounts navigate the volatility with little to no hedging necessary . 

Rising bond prices due to Brexit and other developments have pushed bond yields lower, with the yield on the 10-year U.S. Treasury now below 1.4%. What’s more, yields may remain low for the foreseeable future. (The Bank of England appears set to begin another round of monetary easing.) In that environment, clients who have migrated from Principal Protection to Risk Assist are poised to benefit from Risk Assist’s interest rate flexibility. For example, hedging was triggered in some Principal Protect accounts last week due largely to a spike in bond prices.


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