Madison Weekly Market Wrap July 5, 2016

Market Snapshot

Back in the Black

U.S. stocks rose solidly last week after a rally took hold Tuesday and reversed another Brexit-related decline on Monday. The gains brought the large-cap S&P 500 (+3.2 percent for the week) nearly back to its level before the UK's surprising vote to leave the European Union was revealed in the pre-dawn hours on the previous Friday. These gains also left the S&P and most of the other major benchmarks with gains for the month of June and for the second quarter as a whole. The tech-heavy Nasdaq was again the notable exception, recording losses for both periods. 

UK and European stocks markets also gained ground late last week after Bank of England Governor Mark Carney suggested there would likely be further monetary policy easing there in the next few months. His comments added to pressure on the British pound, which fell to a three-decade low following the UK's vote to leave the EU and pushed the yield on the 10-year UK in the pound and that the bank would "take whatever action is needed to support growth". Both the FTSE 100 and the pan-European Stoxx Europe 600 ended last week higher, if not as strong as markets here. 

S&P stripped the UK of its AAA credit rating last Monday after warning that a vote to exit the EU threatens the country's constitutional and economic integrity. Fitch followed, cutting UK ratings one note to AA. S&P also lowered the EU's long-term credit rating to AA from AA+, noting that the UK's departure will require complicated budget negotiations, which would create significant uncertainty. The IMF called Brexit the biggest current risk to the global economy as financial tremors from the UK decision threaten further to destabilize the world. The statement signaled a downgrade in the IMF's July forecast for global growth, which is currently 3.2 percent this year and 3.5 percent for 2017.

Brexit concerns were still at the forefront as last week began, pushing the major indexes to their lowest levels since early March. Funds designed to exploit market volatility appeared to drive much of the selling, but traders clearly continued to worry about the implications of the Brexit vote on global trade and business investment.

Growing confidence that those implications would only pay out over the longer term, if at all, seemed to help drive the rebound that began on Tuesday, as may have speculation that Britain would at least delay formal exit procedures (which would take two years in any event). Traders were encouraged by a number of merger announcements and takeover bids, suggesting that companies were conducting business as usual in the wake of the vote. As global markets headed higher (including the U.S., Japan, China, and emerging markets), short covering -- or the need of some investors to hedge against bets that stocks will go down -- appeared to accentuate the upturn.

Some positive U.S. economic data also boosted sentiment later in the week. The economy's first-quarter growth estimate was revised upward due to better readings on net exports and business investment. Consumer confidence jumped in the month, reaching its highest level since October of 2015.

The benchmark 10-year U.S. Treasury note briefly reached a record low in yield market last week, but that asset class later retraced its losses with both better-quality and more-volatile issues grinding higher as buyers returned to the market. Investment-grade corporate bonds also followed equities higher as a relief rally took hold. Issuance increased and investors displayed a robust appetite for new deals as month-end buying helped sustain the positive momentum.

Municipal bonds performed pretty well last week despite a pause in the wake of the post-Brexit rally in risk assets. Last Thursday President Obama signed legislation that will set up an oversight board to help Puerto Rico restructure its debt. The U.S. commonwealth has about $70 billion in overall debt and has been a significant issuer in the municipal bond market because of its ability to issue bonds that are tax-free in all 50 states. Puerto Rico has defaulted on several debt obligations over the past year, including $2 billion that was due July 1, badly weakening the value of Puerto Rican paper, necessitating the need for legislative action.

Chart of the Week

Book of the Week

The 4th of July conjures up memories for most of us, and baseball was and remains a big part of the American sporting life. In their new book, The Only Rule Is It Has to Work: Our Wild Experiment Building a New Kind of Baseball Team, Ben Lindbergh and Sam Miller describe the ultimate in fantasy baseball. They got to pick the roster, set the lineup, and decide on strategies -- with real professional players, in a real ballpark, in a real playoff race. Lindbergh and Miller got to help run an independent (very) minor-league team in California, the Sonoma Stompers, using the best analytics and the most advanced statistics. We tag along as the authors apply their number-crunching insights to all aspects of assembling and running a team. It's a wild ride, by turns provocative and absurd, as Lindbergh and Miller tell a story that will speak to numbers geeks and traditional baseball fans alike. And they prove that you don't need a bat or a glove to make a genuine contribution to the game.

Fact of the Week

The United Kingdom accounts for about 13 percent of the EU's population and roughly 15 percent of its economic output. To put this into perspective, Brexit would be akin to the Northeast region of the United States, including the financial hub of New York, choosing to secede from the union because of a belief that the region pays more in taxes than it receives in returned benefits.

Quote of the Week

"Infostorms may be generating a new type of politics: the post-factual democracy. Facts are replaced by opportune narratives and the definition of a good story is one that has gone viral."

-Vincent F. Hendricks

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