Analyzing the Brexit Fallout in ETF and Currency Spheres
The United Kingdom will leave the European Union after the referendum vote known as Brexit won 52% to 48% on Thursday.
The European Union – often known as the EU – is an economic and political partnership involving 28 European countries, which began after World War Two to foster economic co-operation, with the idea that countries which trade together are more likely to avoid going to war with each other.
It has since grown to become a “single market” allowing goods and people to move around, basically as if the member states were one country. It has its own currency, the euro, which is used by 19 of the member countries, its own parliament and it now sets rules in a wide range of areas – including on the environment, transport, consumer rights and even things such as mobile phone charges.
ETF Trends reached out to leading experts relating to how the Brexit vote will affect exchange traded funds and currencies.
From S&P Global Market Intelligence:
By Todd Rosenbluth, Director of ETF & Mutual Fund Research
With the U.S. stock market selling off and investors flocking to the relative safety of bonds, following the “Brexit” vote yesterday, S&P Global Market Intelligence thinks investors should look closely at to mid- and small-cap dividend paying securities as well as investment-grade focused bond products. Questions are being raised about the economic health of not only the U.K., but the remaining E.U. countries, and these U.S. companies are more insulated according to Sam Stovall, U.S. equity strategist for S&P Global Market Intelligence. In addition to individual stocks, there are some strong income oriented ETF choices to consider relative to the 1.57% yield offered by the 10-year Treasury bond.
ProShares S&P Mid Cap 400 Dividend Aristocrats (REG) holds 46 companies that have raised their dividends for 15 or more consecutive years. Financials (28% of assets), utilities (20%), and industrials companies (17%) are well represented in the portfolio, but all GICS sectors but energy have representation. Investors that are seeking individual stock ideas can look inside here for inspiration, but should be aware not all securities are undervalued.
Related: Revisiting An International Dividend ETF
For investors seeking small-cap dividend approach, WisdomTree Small Cap Dividend (DES) is a strong candidate. Rather than focusing on the dividend record of the company, as REGL does, DES looks at the dividends the company is projected to pay in the coming year. While financials (25% of assets) and industrials (17%) are widely held, so are consumer discretionary (17%) securities.
Meanwhile, SPDR S&P Dividend (SDY) holds a mix of large-, mid-, and small-cap stocks within the S&P 1500 index that have raised their dividends for 20-plus years. While AT&T (T) is a top-10 holding, so are mid-caps National Retail Properties (NNN) and Old Republic International (ORI). Financials (24% of assets), industrials (15%), and utilities (14%) are the largest sector exposures for this ETF, which has a 0.35% expense ratio.
We think dividend-growth focused ETFs remain appealing, particularly as the flight to safety has pushed down bond yields. For investors who are still looking for traditional income in the form of bond ETFs, should also consider investment-grade bond products that look beyond traditional Treasuries.
The passively managed iShares iBoxx Investment Grade Corporate Bond (LQD) and the actively managed SPDR DoubleLine Total Return Tactical (TOTL) are two such examples that take on moderate credit risk, but offer compelling yields. Both have 3% 30-day SEC yields, though they hold different bonds.
From the KCG ETF Team:
By Brian Gilman, ETF Trading
With markets pricing in very little chance of a leave vote, the response has been STRONGLY negative. S&P Futures are off 3.6 % currently, trading as low as 1999, Nasdaq and Dow Futures are also off over 3 percent. The real carnage is expected in Europe—the bank heavy (most exposed sectors) Eurostoxx index is off nine percent, while the FTSE 100 is off 4.7%. CAC and DAX futures are off 8.5 and 6.5% respectively, while Spain’s IBEX is the worst hit, down 12%.
The US 10 year yields sit at 1.53, gold has rallied 5% and the Dollar Index is up 2.5%. The Japanese Yen, a safe-haven currency in times of distress is up 3.6% vs the dollar and 6.5% vs. the Euro.
Related: Going Local With Emerging Markets Bond ETFs
Discussing the quiet ETF flows from Thursday does not seem appropriate, but I can only stress that traders / investors act as diligently as possible in this environment. Do not send Held market orders in an environment where Volatility is peaking, markets are whippy and spreads are likely wider and thinner…use limits. Consider waiting after the open to execute: ETFs are derivative products and letting the underlying securities find their levels and stabilize (in both price and liquidity) will help your executions.
How the Currency Markets are Reacting
By James Stanley, Currency Analyst at DailyFX
A surprising twist in the Brexit vote has roiled capital markets around the world. While markets were banking on a ‘remain’ vote going into the exit polls, a majority ‘leave’ vote brought considerable risk aversion across capital markets. This led to jaw-dropping moves across the spectrum as the British Pound posted a historic drop to a fresh 30-year low while risk aversion began to run high around-the-world.
The British Pound dropped by 12% in a little over six hours as news of the referendum vote was filtered in to markets. This sent prices below the Financial Collapse low of 1.3500 before recovering; and that recovery has seen a 3.9% bounce off of the lows. And this is a currency, so a 3.9% movement in a day is jaw-dropping, much less a 3.9% movement retracing an earlier -12% slide. This is still extremely volatile, and will likely remain as such at least through the weekend. So, the same advice that we offered yesterday, saying that traders should tread cautiously if at all in these conditions will continue to persist.
But this is still very much a fluid situation: Now that the votes have been cast to leave the European Union, this sets in-place a slow moving political process that could see the divorce between the UK and the EU drag out even longer than the mandated two years.
Related: Currency ETFs That Will Move Regardless of Brexit
First thing first: Yesterday’s referendum isn’t technically legally binding, so Prime Minister David Cameron does not have to honor the vote. But all signs indicate that he is going to respect the will of voters, and this was confirmed earlier this morning when he announced his resignation from his Prime Minster post in order to allow ‘fresh leadership’ to guide the United Kingdom in this new direction. Speaking of the United Kingdom, last night’s vote to leave all but ensures yet another Scottish Referendum for independence, as Scottish First Minister Nicola Sturgeon said on Friday that the country would do what is necessary to secure their place in the European Union. She went on to say that a second independence referendum is ‘now highly likely.’
The next step for Mr. Cameron is to invoke Article 50 of the Lisbon Treaty to begin the legal process for the UK to leave the EU. Once this happens, we’ll see a series of negotiations between politicians from each side to decide exactly how to best organize the impending split. Article 50 allows for two years for this process, but this can be extended by both sides agreeing to the need for additional time. The UK has been a part of Europe since the EU’s predecessor, the EEC, since 1973; and this has produced decades’ worth of trade deals and legislation that will take some time to unravel.
On Tuesday and Wednesday of next week we have an EU Summit (June 28-29), and this could be an opportunity for Mr. Cameron to give notification of the UK’s intention to leave; although he may wait a few months before doing so in order to allow his successor to take those reigns. It is likely that the topic of Brexit will be at the top of discussions at this summit, and EU leadership has already begun talking about a special meeting to be held in July in which the UK will not be invited so that EU leadership can discuss strategy moving-forward.
The Ramifications Aren’t Localized to Just the UK and Europe
By James Stanley, Currency Analyst at DailyFX
Probably one of the most profound events last night was the global market reaction to a vote to leave. While this was a threat for months leading into last night’s vote, a recent swing to the ‘remain’ side in last minute polls had built-in the expectation that British voters would elect to stay. But as we discussed yesterday, this was a dangerous prognostication because many of those expectations were being driven by bookies’ odds. And while bookies did a far better job of forecasting last year’s General Election, they soundly whiffed on last night’s referendum as they were universally predicting that voters would elect to stay.
The vote to leave brought a near-immediate impact to capital markets. The British Pound fell dramatically to a fresh 30-year low; and the Euro put in an aggressive down-side move as well, dropping by more than 500 pips from yesterday’s high. Risk aversion ran high as the US Dollar strengthened against every currency other than the Yen, and global equity markets put in big moves lower as investors buckled their safety belts for fear of rougher waves ahead. Already we’re seeing rate expectations out of the United States dwindle even further, as markets are now pricing in a 12% probability of a cut in rates by the Federal Reserve before the end of the year.
In response to the massive surge in the Japanese Yen, we heard the Finance Minister Taro Aso pledge readiness to intervene in markets in the effort of quelling Yen strength; and this helped to provide some support to USD/JPY after a quick drop below the psychological 100-level.
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And as the Swiss Franc saw safe haven flows increasing, the Swiss National Bank intervened in the effort of stabilizing CHF. Mark Carney said that the Bank of England was ready to add £250 Billion into the Financial System to offset risk aversion emanating from Brexit, and the European Central Bank said that they are also standing by to add liquidity to markets if needed.
We are likely sitting in front of considerable Central Bank activity, or at the very least the prospect of Central Bank activity, which could certainly hasten volatility across capital markets as the prospect of additional action increases on the back of the impending Brexit.
Another market that saw considerable capital flows in the realm of risk aversion was Gold, as prices ran up by as much as 8.6% overnight as news of the referendum filtered through markets. That move has moderated, and Gold is currently up 5.9% since yesterday’s 5pm ET close, and if we are, in fact, sitting in front of more Central Bank action, this is likely a market for traders to focus on. While the US Dollar and Japanese Yen may have to contend with intervention or ‘loose policy’ threats from Central Banks, Gold can continue to see capital flows as investors look to harness the risk of their portfolios.”
