The Brexit vote shocked both pundits and portfolio managers, but investors seem to be recovering from their shock remarkably quickly. Nonetheless, the rebound has been a bit unusual in one sense.
The initial sell-off played to script. Stocks sold off and investors rotated into classic so-called “safe-haven” currencies, Treasuries and gold. The rebound has also followed a well-worn path: Central banks made soothing noises and investors dutifully re-purchased the stocks they just sold.
There is, however, one wrinkle. Demand for the safe-haven assets, such as gold and Treasuries, that are typically sold during “risk-on” rallies remains strong. Despite the rebound bonds remain popular, with yields now at or close to historic lows, and gold is just a few dollars off of a two-year high.
Why are investors unwilling to surrender their financial safety blanket? There are a few possibilities:
1. The marginal buying in stocks came from cash
Rather than selling bonds or gold, investors dipped into their considerable stockpile of cash to purchase stocks.
2. The rally was mostly about short covering
There is some evidence to support this. Stocks with high short ratios bounced hard during the rebound.
3. Investors are happy to chase a short-term rally, but don’t really trust it
Following the vote investors decided the Federal Reserve was more likely to cut interest rates rather than raise them. Based on the prospect for more easy money, investors were only too happy to participate in a quick bounce, but weren’t setting up for a longer stay.
4. High bond prices and low yields represent a capitulation on global growth
Despite the central bank induced rebound, this latest geopolitical shock may have convinced investors that we’re never escaping the low growth sand trap.
At this point, I’d lean towards some combination of 3 and 4. Notably, trading volume has been considerably lighter on the way up than it was on the way down. That speaks to investors not really trusting the rally.
At the same time, investors may appreciate the short-term sugar high from an accommodative Fed, but they don’t seem any more optimistic about the prospects for an economic rebound.
After all, not only have bond yields remained low, but bond market proxies such as utilities, rallied along with the rest of the market. If investors were convinced that Brexit was a meaningless blip and that growth was set to accelerate, utilities would have been more likely to trail than lead.
In short, a certain amount of skepticism about the recent rally seems prudent for now.