Our Opinion: 2016

US shrugs off Brexit

The US market was shocked by Brexit. US companies get about 13% of their revenues from continental Europe. But Brexit’s impact will not likely be that significant and most unlikely to deal a lasting blow to US stocks. It’s not like the UK is going to remove itself from the world economy and not trade with anyone. Once the emotion fades, there will be renewed focus on the improving fundamentals.

America has a relatively insulated economy, with exports accounting for less than 15% of GDP. The equivalent figure for the euro area is around 40%. Similarly, US firms generate 70% of their sales at home, compared with 58% and 49% for their Japanese and European counterparts respectively.

The Federal Reserve’s reluctance to upset markets by raising interest rates is also good news for asset markets, and Brexit-related jitters provide a good excuse to delay increasing interest rates. That will give the liquidity-fuelled bull market a little more breathing space.

After the UK’s Referendum result, UBS reduced the 2016 GDP forecast in the Eurozone from 1.6% to 1.3%. However, the post-Brexit decline in interest rates is stimulus for other segments of the global economy, particularly emerging markets and US housing.

With US wages beginning to rise, there are concerns that there is a risk that profit margins could begin to decline. However, it makes more sense to focus on earnings growth. And the historical record is clear that there is no discernible relationship between wage growth and earnings growth, largely because consumers tend to spend virtually all of the increase in wages. This is especially true at the lower end of the labour market, where pay rises have been gaining the most headlines.

Perhaps most importantly, the US economy is showing signs of improvement. A key indicator for the manufacturing is at its highest level in over a year. Weakness in the cyclical manufacturing sector was a key driver of the sell-off in US equities in January and February of this year and the subsequent improvement has been behind the rebound in equities since then.

US consumers are benefiting from energy prices that are reasonable, fairly consistent job gains, wage growth that is beginning to slowly improve, and mortgage rates that are now back near historical lows. All of this points to moderate, mid-single earnings growth.

Without a doubt, investors will be looking for clues from earnings reports in order to determine the impact of the UK referendum on the US economy and S&P 500 profits. US equity markets have largely shrugged-off the election outcome. Whilst the UK economy will likely slow in the short-term, US exports to the UK are only a very small percent of US economic activity.

Brexit’s impact should be neither significant nor protracted.

13th July 2016