Two weeks ago, stock bulls were complacently expecting new highs in the major indices despite what they regarded as the likelihood of a rate hike by the Federal Reserve. Now, not so much.
The news of the day is Brexit…the June 23 referendum in which the British vote on remaining in the European Union. The market had priced in a decision to remain but recent polls show the Leavers are now winning. This seems to be another manifestation of the anti-establishment mood that has driven the campaigns of Donald Trump and Bernie Sanders. Authorities are being challenged all over the planet. And that’s the real significance of the Brexit vote; if the Brits leave, others will more than likely follow and a pillar of the conventional universe…a united Europe…will fall.
For equities, this could well be the straw that breaks the camel’s back. The charge higher in stocks and high-yield credit since February 11 has been one of the strongest and broadest rallies in history and for stocks it stopped just short of new highs. Will this turn out to be another infamous failing rally just before the bottom falls out…a repeat of 2008? If Brexit was happening in a period of rising economic growth and sound finance, markets could shrug and move on. This is not one of those times. The world economy is slowing down and debt levels are now much higher than they were in 2008. The situation is precarious at best.
What can we expect now? The most certain prediction I can make is that the central banks will do more of what isn’t working…monetary stimulus. Brexit is a risk-off event that will reduce system liquidity, sending money to the sidelines. The central banks will try to push this money back into risk assets, increase lending and generate more liquidity. Listen to the central bankers. They are saying they can and will do more if necessary. They don’t know anything else. Therefore expect more currency instability and market volatility, falling confidence and growing risk aversion until the central bankers finally lose control of the credit markets.
The logical answer to these developments is gold, as I have been saying for the past five months. Gold is trying to correct from a seriously overbought condition but issues like Brexit and the slowing U.S. economy are over-riding the correction which has been driven at least in part by the Fed’s stated policy of normalizing interest rates. Fed rate hikes are getting more remote with each passing day and nearly every economic report. I’m not yet confident gold’s correction is over but if you do not already own gold, you should consider getting some. It could be getting ready to explode.