Stock Market: Brexit Fallout Lingers

As we approached the end of July, the stock market rallied following several weeks of volatility as markets here tried to adjust to Britain’s decision to leave the European Union. The Standard and Poor’s 500 index rose to reach a record high on July 24, posting a fourth straight week of gains; a 6.4 percent gain for the year-to-date and a solid 4.6 percent gain over a 12-month period. By the end of the third week of July, the Dow Jones Index was up 53.62, marking a year-to-date increase of 6.6 percent and a 5.7 percent gain over this time last year. NASDAQ also closed up for a year-to-date increase of 1.85 percent and a 0.23 percent gain over 12 months.

Does this post-Brexit bounce mean we are past the tremors caused by the June referendum vote? Not exactly. Pundits are glad to see a return to more stability, but many think the fallout from the surprise Brexit vote will be with us for a while longer. Here are some key observations made by leading investment experts.

• Although the U.S. economy and U.S. stocks have limited direct exposure to the Brexit fallout, the interconnectivity of global business and finance means that U.S. businesses could be affected adversely by an economic downturn in Europe and beyond.
• Many analysts see tighter financial conditions ahead. When it’s harder to get loans, we see a slowdown in business and economic growth and less investment in the stock markets. Economists anticipate this happening in Europe and beyond, but acknowledge that this could spread to the United States, too.
• Some analysts anticipate that Brexit will affect U.S. companies’ earnings adversely. Earnings from companies in the S&P 500 have been in a general decline since the third quarter of 2014. Profits and stock prices tend to follow the same trajectory, which is why the overall stock market has been mostly flat for the past two years. Prior to the Brexit vote, many analysts were hopeful that rebounding oil prices and signs of global recovery would help push earnings higher. The surprise vote by the British to leave the E.U. has dashed much of this optimism.
• Second quarter corporate profits in the United States are unlikely to be hurt by Brexit. The British vote came at the end of the earnings cycle. However, many analysts had hoped that profit increases in the second quarter would continue into the third and beyond. Now, many analysts are refiguring their projections for the remainder of the year.
• The dollar has climbed against the British pound and the Euro, resulting in exchange rates that we have not seen since the mid ’80s. U.S. companies that derive significant revenue from overseas sales are hurt by the stronger dollar, which makes goods from the United States more expensive to foreign buyers. Information technology companies are especially hard-hit by the strengthening dollar – more than 50 percent of their sales are overseas.
• In the United States, wages have begun to increase after a long period of cost-cutting and slow productivity gains. Although this translates into increased consumer spending, it also puts more pressure on corporate profits. Conversely, wage increases have fueled earnings growth for companies in the consumer discretionary category (appliances, cars and home electronics) and this sector is expected to continue its upward trajectory.

We head into the second half of the year with the stock market at a record high but with the prospect of volatility on the horizon.

The commentary above is intended only as a general overview. Individual investors should consult their tax and investment professional advisors for specific investment advice.