Blaming Brexit                                                                                                                                             By Brad Thomason, CPA

 

So I guess you could say that the markets didn’t like that whole Brexit thing.

Truth is, it probably wasn’t personal.  Markets, as a rule, don’t like instability or uncertainty of any kind.  The question of whether or not Britain would stay in the EU – whether or not the EU was ever destined to survive in the first place, for that matter – were out there well before the vote ever came about.  But these things can often trace weird trajectories, and the act of moving toward a more certain result can cause more uncertainty in the moment.  Which brings us back to the market: general uncertainty is never popular; but point-specific acts of uncertainty move prices.  And not in the good way.

Prices across the globe and across many assets fell.  Then a few days later they came back up.  We will find out this week if the bounce will hold, or if prices trend back lower from here.

If stock prices fall from the current point, then the commentary will be that the Brexit vote “caused” US markets to decline.  The implication of this statement will be unavoidable: but for them, our brokerage accounts would have been just fine.

But here’s the thing.  Stock prices usually fall in the summer.  It happens more years than not.  It would be an exaggeration to say it’s destined to happen, but then again it is such an enduring assumption within the professional investor community, one could not be faulted for categorizing the whole thing as self-fulfilling prophecy.

Moreover, this year, there’s even more to the story.  For over a year now prices have gotten up to the level of 18,000-ish on a number of occasions, but have not gone any higher.  This is something that is a pretty standard pattern of behavior in all financial markets.  It’s the condition predicted by those supply and demand nuggets from Econ 101.  The asset value ascends to a point where there’s not really anything left to push it any higher.  An incremental upward change in price causes demand to essentially evaporate.  No one is willing to pay more for it than its current price.

Notably, the prices don’t fall right away.  They just sort of hover.  It’s the market equivalent of a “now what?” moment.

Such moments generally resolve themselves one way or the other.  You guessed it: up or down.

The up case, at least an up case that is enduring, is based on some development or set of developments which causes investors to see the asset in a new light, one in which there is consensus agreement that it is perfectly reasonable for prices tomorrow to be markedly higher than they were yesterday.  A great example of this is what happened to oil prices when the US started its invasions of Iraq and Afghanistan.  No one knew what was going to happen, and no one knew if oil from that region was going to still flow to world markets.  All of the sudden, a barrel of oil already in hand looked like a pretty valuable thing to have.  The case for more expensive oil was pretty clear, and oil prices rose and stayed there for several years.

But just as US stocks seem to have stalled for the moment, so did the price of oil.  You can pay too much for anything, and when oil got up over $100 a barrel, people started pulling back on the throttles.  Oil didn’t fall.  But neither did it continue its ascent at the same rate.

You can think of a stalled asset price as being analogous to standing in the middle of the highway.  If you stay there long enough, there’s a fair chance you are going to get whacked sooner or later.  The make and model of the vehicle which hits you are not likely to be very important.  You were ripe for an impact, and the numbers just caught up with you.  Sorry.

Stalled out asset markets usually fall pretty quickly, usually on the back side of a significant news event.  So it is not hard to see why people say that X caused Y.  But the point of this whole post is that there is a never-ending stream of significant news stories, just as there’s always another car coming down the highway.  A market that is poised to fall, sooner or later, will.  It will find a reason.

The Brexit vote may in fact be the triggering event if things head back south this week.  But the Brexit vote was not the force keeping US stock prices from ascending beyond the gravity field of 18,000 for the past year and a half.  Nor is the Brexit vote responsible for the long-running tendency for prices to retreat in the summer.  No one knows what is going to happen when Britain leaves the EU, so the instability and uncertainty being reflected in prices right now are certainly real.  It’s not that this is not a substantive event.

But the point is, even if it hadn’t been this substantive event, it probably would have been something else.  That’s the history lesson of past market moves.  When an asset price stalls, something is going to come along and hit it.  Occasionally it will be something specific to that asset which logically justifies a new value, and the price rises.  More often though, some point of uncertainty – any point of uncertainty, directly related to that asset, or not – will come along and knock the price lower.

US stocks have been standing in the road for quite awhile.  And it’s summer.  Something was going to come along and whack them, one way or the other.  The only real news here will be that we finally found out what that something ended up being.  Doesn’t make it less real.  But it is another example of how looking for answers that are too simplistic can lead to conclusions which don’t incorporate all of the facts.

Predicting the Brexit vote might have been impossible.  But seeing that prices were stalled is something that could have been accomplished with a 5 second glance at the chart any time in the past few months.