July 13, 2016

Scott L. Wren, Senior Global Equity Strategist

Sick of Hearing About Brexit? You Haven’t Heard Anything Yet

  • The major stock indices may have rallied back quicker than we thought they would. Current levels are justified by the fundamentals, in our opinion.

What it may mean for investors

  • We do think minor pullbacks are likely in the near term. Look at any downside as a buying opportunity.

When the future is rife with uncertainty and everyone from the Federal Reserve (Fed) to corporate CEOs is biting their fingernails due to a bad case of anxiety, the search for a scapegoat shifts into overdrive. In the 30-plus years this strategist has been watching the stock market, it seems some event or potential event must be found from time to time on which to lay blame for poor performance. Or to explain a lack of clarity when attempting to divine the future. Some in the investing world expect the Fed and corporations to have a clear and accurate view of what is likely to occur down the road. Note that we are not in that camp. In anything but the most optimal economic environments, the Fed and corporate projections will often be erroneous. This has been especially true in the current cycle.

As we begin to work through the initial portion of the second-quarter earnings reporting season, one thing is almost certain: The scapegoat this time around is going to be the U.K. electorate’s decision to leave, or exit, the European Union (EU). Or, as the media have deemed this action, “Brexit.” Keep in mind that this single event, which will literally take years to play out, sent the stock market very briefly into panic mode and has politicians in the U.S. and across Europe (especially in Brussels) worrying about the “end of globalization” among other unlikely occurances.

Many corporate executives have joined ranks with these politicians in their predications of global mayhem and decreased trade in an already slow-growth world economy. However, note that multiple surveys taken after the vote have shown that the vast majority of U.S. companies expect very little negative effects to their business and profitability.

But don’t expect this optimistic attitude to show itself over the course of the next four or five weeks as earnings results for the second quarter are reported and forecasts are conveyed. Our Equity Strategy group is calling for “adjusted” earnings to be down 4 percent on a year-over-year basis when all results are tallied. We expect to see negative earnings comparisons for six of the 10 sectors. We believe only one sector, Consumer Discretionary, is likely to post double-digit growth versus the year-ago period. Energy sector earnings will likely be down close to 80 percent if our analysis is correct. In other words, there is a lot of bad news to report and a lot of blame to be spread around (the stock market, in our opinion, already has the second quarter’s poor performance priced in).

This strategist hates to be the bearer of bad news, but be ready to be hit over the head constantly with references to the U.K. referendum during this earnings reporting season. Many companies will express a guarded outlook, and some might even try to tell investors that the uncertainty going into the vote contributed negatively to performance in the second quarter. But even worse, it is likely that over the next eight to 10 (or even more) quarters companies will be going back again and again to using Brexit as an excuse for underperformance. This scapegoat isn’t going away any time soon. Sick of hearing about Brexit? You haven’t heard anything yet.

Risk Factors

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There is no assurance that any of the target prices or other forward-looking statements mentioned will be attained.

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