The US market was truly shocked by Brexit, Societe Generale’s Andrew Lapthorne told UK.BusinessInsider.com. But that is only because it had spent the previous few days “anticipating exactly the opposite” result. Complacent investors had bid stocks up beforehand, making the Brexit-induced slide seem more serious than it really was.
The S&P 500 fell by 3.6% last Friday, and there were further, smaller declines early this week. But Brexit is highly unlikely to deal a lasting blow to US stocks. “It’s not like the UK is going to remove itself from the world economy and not trade with anyone,” says Wells Capital Management’s Jim Paulsen. “Once the emotion… fades”, people should refocus on the improving fundamentals.
Imports and exports to the UK comprise less than 5% of America’s overall trade in goods and services. America has a relatively insulated economy, with exports accounting for less than 15% of GDP. The equivalent figure for the euro area is around 40%. Similarly, US firms generate 70% of their sales at home, compared with 58% and 49% for their Japanese and European counterparts respectively.
In addition, the economy is picking up speed after slowing to a crawl in the first quarter. The healthy labour market bodes well for consumption, which is worth 70% of GDP. Following a big recent jump in retail sales, real household spending should average an annualised 3% in the second half of 2016, reckons Capital Economics. And with unemployment heading towards 4.5% next year, wage growth should climb further. The Federal Reserve’s reluctance to upset markets by raising interest rates is also good news for asset markets, and Brexit-related jitters provide its latest handy excuse to sit tight. We may not see higher rates until 2017. That will give the liquidity-fuelled bull market a little more breathing space.
Another key factor is the earnings backdrop, and here too the news looks better. The energy sector is now recovering, while its sharp profit declines are falling out of the annual calculations. The same goes for the squeeze to overseas earnings from the strong dollar. The heavyweight tech sector also looks robust. S&P 500 firms could produce earnings growth of 13.5% in 2017, compared with the 0.9% expected in 2016, says Ed Yardeni of Yardeni Research.
None of this means stocks will soar. High valuations spell poor long-term returns. The S&P is on a price/earnings (p/e) ratio of 18.5. The cyclically adjusted p/e of 26 is far above the 135-year average of 16.6. And the Fed is still likelier to raise than cut rates or restart quantitative easing, which makes it the least supportive major central bank. But Brexit’s impact should be neither significant nor protracted.