The recent United Kingdom vote to exit the European Union, a move commonly referred to as Brexit, has rocked financial markets worldwide. While many people scrambled to pull their money and stocks out of the market in fear of a worldwide fallout, equity and bond purchases have suddenly risen as policy makers and financial gurus have come to the rescue by dropping interest rates and encouraging stimulus options.
The Changing Relationship Between Stocks and Bonds
In traditional financial markets, stocks and bonds do not move in the same direction, such as both increasing in sales at the same time as they are right now. When one asset class is flourishing, the other typically suffers. However, as the news of the impending Brexit has created an unprecedented monetary change, that relationship continues to evolve in unknown ways.
Since the 2008 United States financial crisis, the stock market mentality has often been that of a knee-jerk reaction. When something terrible happens, shareholders immediately pull their stocks, but the market often rapidly rebounds just a short time later. This is what happened after the historic vote in the U.K.
Now government bonds are paying less than zero across the board, but United States stocks are reaching all-time value highs. This leaves many investors trying to buy up more bonds at record-low interest rates while simultaneously scratching their heads at the lack of change in stock prices.
The Influence of the Long Game
Despite the initial worries over the effect of Brexit on the U.S. economy, investors continue to rush back into equities feeling more confident about the state of the economy. Recent data shows that the U.S. factory output is continuing to grow, boasting levels higher than they have been in the past year. The S&P 500 Index has also rebounded quickly, nearly erasing any initial damage following the U.K. vote and recording its best week since last November.
In addition, promises by U.S. policy makers and the central banks have made it clear that they are ready to act in the event that the Brexit decision somehow threatens to destroy the U.S. economy. While low treasury bond yields would traditionally indicate a dire financial circumstance, most advisors do not see the current situation that way. In fact, the meager yield of these bonds is actually appealing to more global investors who are willing to play the long game with their bonds.
To keep the bond market safe, interest rates are expected to remain at a drastically reduced rate for the rest of the year or possibly even longer. Bonds currently being purchased at these exceptionally low rates are meant to not mature for decades, giving the market ample time to rebound and improve their worth.
However, this does not help the economy now.
Equities and the U.S. Economy Rally
Worldwide central banks have been focusing on the reality that there is a lot of liquidity left in the international market, even as sovereign debt is forcing investors to pay for currently worthless government bonds. However, these central banks are offering many stimulus programs designed to assist these purchases to get worldwide markets turned around.
With equities retaining their much higher values, many investors are bidding up these stocks, and that market has seemingly rebounded quickly. However, as Marwan Naja, CEO of Swiss Private Equity firm Manixer, points out, no country has ever taken the drastic step of actually leaving the EU. The worldwide economy is therefore unpredictable, and even the impressive rebounds of the U.S. market could be erased when the Brexit officially occurs.
Policy makers who have lowered interest rates and encouraged this type of recovery must be wary and watch the equity and bond markets daily to keep the global economy on track. Although these experts may not always understand the actions that are maintaining the finances, they must continue to look for ways to keep this unprecedented Brexit from destroying the world market.