Peter's Perspective
15th June 2016 by Tama Churchouse

In the Eye of the June Storm…

On the 31st of May we wrote that June was going to be a big month (see the appropriately titled Peter’s PerspectiveJune’s a BIG month… consider this short-term trade”).

We’re halfway through and… well…

Sure, U.S. payrolls came in at a dismal 38k versus expectations of 160k (on top of downward revisions for both March and April).

But the big kicker has been the U.K. referendum on Great Britain’s membership of the EU. Two weeks ago the polls were split pretty evenly, with perhaps a modest lead for the Remain camp.

Today, most polls put the Leave camp ahead.

The implications of Britain voting to leave the EU would be utterly profound and extremely destabilising.

In my humble opinion, if the U.K. leaves then I think you should prepare for an accelerated dismantling of the entire European Union construct as we know it over the next decade.

Bear in mind the French have a less favourable view of the EU than the British! And the Spanish are barely more so according to recent polls by the Pew Research Centre.

‘Brexit’ would further ignite Eurosceptic and Nationalist parties across Europe, and all at a time when the region remains so economically fragile.

It’s tough to be an optimist right now, although despite the lead in the polls, we believe the U.K. will remain in the EU. There is still a sizeable percentage of the population (up to 15%) who are undecided.

Typically that block tends to stay with the status quo on voting day. And the bookies still have the U.K. staying in the EU with a probability of 63%.

Regardless, the extremely close polling and subsequent impact on markets have at least provided a glimpse of the contents of this Pandora’s Box of potential instability.

What to do?

Well, we tried to answer that question a couple of weeks ago.

Specifically, we said,

Given how busy the calendar is over the next 30 days, it could be worth looking to take a short-term view on volatility.

It doesn’t appear that markets are particularly rattled right now…

Since then, market has woken up a bit (see chart below).

CBOE VIX (Volatility) Index - 1 Year Historical Data from May 2015 - Mid June 2016.

Our short-term tactical recommendation [iPath S&P 500 VIX Short-Term Futures ETN (VXX US)] is up roughly 20% but I’ll stress again, this is not a buy-and-hold ETF.

Not only has U.S. equity volatility spiked, but we’ve seen government bond yields get crushed.

The 10-year U.S. treasury yield is down 0.22% to 1.60%. German Bund yields are now negative. Nearly the entire Swiss government debt offering is now offering negative yields.

And of course it we can’t forget Japanese JGB’s which hit yet another record low of nearly -0.20%.

[The onward march towards and further into negative yields is not surprising. We wrote about it in the May edition of The Churchouse LetterThe Uncharted Waters of Negative Interest Rates”.]

For most investors, keeping powder dry is likely the best bet right now. Brexit in particular will be a one-day-at-a-time story for the next 10 days.

China’s continued exclusion from MSCI’s benchmark indices (third time now!) were shrugged off by the Chinese equity market.

As Peter wrote earlier in the week (“Is China In? Or Out?”), our base case was for a small inclusion of 5% if that.

But he concluded;

Either way, I don’t think MSCI’s partial inclusion of the “A” share market into its indices is a good enough reason to go out and load up on these stocks yet.

Nothing changes there then, and a general “risk-off” approach should do fine to see out what is turning in to a particularly busy month.

Good investing,


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