Brexit Aftermath: What We Learned Today

S&P 500 sector performance reflects continuation of post-Brexit risk-averse environment. The defensive, high-dividend-paying sectors (utilities, telecom) are leading the way again today, as they did on Friday, as market participants seek safety and Treasury yields continue to slide to near post-Great Recession lows. As is typical on a down day of 1% or more, large cap stocks are holding up a bit better than small and mid. The sectors down the most today are those most sensitive to the Brexit—specifically, financials and commodities. Financials are being impacted by European bank contagion fears and lower interest rates, while the strengthening U.S. dollar and global growth fears are hurting the energy and materials sectors.

Uncertainty is driving markets again. Markets crave certainty and want to see swift and substantive progress in the U.K.’s negotiations to leave the EU. Developments today on the aftermath of the Brexit vote were, at best, a mixed bag.

The Good

New Conservative leader a month earlier than expected. The U.K.’s ruling Conservative Party said it will elect a new leader “by September 2, 2016,” to replace outgoing Conservative Leader (and Prime Minister [PM]) David Cameron, who resigned as PM after unsuccessfully leading the “remain” camp. While two months with a lame duck PM seems like a long time, it’s a month sooner than most thought as of just a few days ago, when Cameron said he would remain in place until October.

U.K. government hints at team charged with EU negotiations. An “EU unit” has been set up in the U.K. government to begin doing the groundwork ahead of the negotiations with the EU. The leading candidate to be the new PM, former mayor of London Boris Johnson, said today that he would like to see the U.K. retain access to the EU’s single market.

Potential fiscal “impulse” in the EU. German Chancellor Merkel hinted at an EU leaders’ summit today that the EU may propose “a new impulse” for the EU aimed at lowering youth unemployment. Until now, the odds of the EU enacting any sort of fiscal stimulus were close to zero.

The Bad

The U.K. has yet to invoke “Article 50.” Invoking Article 50 formally notifies the EU of the U.K.’s desire to leave. The negotiations between the U.K. and EU can’t begin until this happens, and the longer the U.K. waits, the longer the uncertainty lingers.

S&P downgraded the U.K.’s debt rating to AA from AAA. While the markets largely expected the move, it raises the odds that the U.K. will have to enact some fiscal austerity measures later this year, exacerbating and likely prolonging the period of economic weakness that is now taking hold.

Political leadership vacuum persists. A battle has already begun amongst Conservatives to replace departing PM Cameron, and the main opposition Labour party is in turmoil, with almost half of Labour head Jeremy Corbin’s leadership team leaving their posts in the past few days. Markets want to see some order restored so negotiations can get underway and proceed quickly.

Tensions among EU leadership. German Prime Minister Angela Merkel has counseled a “go slow” approach to the U.K. leaving. The U.K. is one of Germany’s primary export markets, and it is in Germany’s best interest to have a go slow approach, while preserving the possibility, however remote, that the U.K. will change its mind. Other officials within the EU have suggested that the U.K. should leave as quickly as possible.

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