July Outlook: Brexit, Terror & Election Cast a Pall Over Worst 4 Months
By: Jeffrey Hirsch & Christopher Mistal
June 30, 2016
Leading up to Brexit markets were held back by concerns that Britain would leave the EU. Then a few days prior consensus was that the UK would stay in the EU and the markets rallied smartly. Then when everyone was wrong on Friday morning, markets around the world sold off sharply for two days. Then when Article 50 and the logistics of leaving made it apparent that nothing would happen soon, markets rallied back toward pre-Brexit levels. 
There is some buyer’s remorse from those that voted for Britain to exit the EU. Political leaders in the EU have expressed anger and encouraged a swift exit. Yet citizens across the Union have also expressed interest in leaving. At the same time there is a political vacuum in Britain with no clear successor to the outgoing, resigning Prime Minister Cameron. Meanwhile, despite a sharp two-day selloff in global equities last Friday and Monday, the market now appears rather unfazed after being extremely nonplussed for two days.
Perhaps as is often the case, all the fear of the dire consequences of a British exit from the EU are quite overblown. Of course there are risks, but there are always risks. Remember this vote is non-binding it is just a recommendation by the voters to Parliament that 52% of them would like to leave the EU and 48% want to stay. It still remains to be seen if Brexit will actually happen and if it does how detrimental it will be to the UK, EU and global economies and markets. However, we believe it will proceed and the UK will leave the EU.
Much remains to be figured out, but let’s step back for a moment and take all the worst cast scenarios with a grain of salt. Will Brexit really happen? Who will be the next Prime Minister of the UK. Will others leave? What will happen to the EU? Will Brexit hurt the UK or EU more? 
In the long run Brexit will likely be a blessing in disguise. It has the potential to strengthen both the UK and EU, by freeing up the UK, which is the 5th largest economy in the world and not in the Eurozone to set its own economic path, and catalyze the EU to hone its structure. In the near term, however, it is likely to add to market volatility and hamper economic growth as the powers that be figure out the next steps to Brexit and are pulled away from concentrating on implementing economic growth policies and initiatives. 
Stock Trader’s Almanac seasonality, probabilities and strategies proved themselves this past week. This Brexit event happened in the “Worst Six Months” and we came in to the situation positioned defensively and will remain so through the balance of summer and into the early fall. Market weakness this June was not emblematic of the more bullish election year June scenario. The inability of the market to log new all-time highs and gain any ground this June, or this year for that matter, underscores the lack of upside drivers in the near term. 
As the UK and the EU figure out what the heck they are going to do, and the US hunkers down for the battle for the White House to heat up, we are dealing with an alarming increase in terror attacks around the world. All this has the market on edge and primed for a further correction this summer. After the snapback rally from the Brexit shock recedes and early-July seasonal bullishness dissipates, look for lower prices and a test of the 52-week lows over the next four months. Stay the course.
Pulse of the Market
Losses from last week’s surprising Brexit vote outcome have not been recovered yet. As a result, both the faster and slower moving MACD indicators (1) applied to DJIA remain negative. Since first closing above 18000 in December 2014, DJIA has failed to move meaningfully higher and hold onto gains and since last July DJIA has spent about the same amount of time below its 200-day moving average (solid red line) as it has above it (2). This key support level is approximately where DJIA bounced from earlier this week, but it would not be surprising to see it violated again sometime later this summer.
Dow Jones Industrials & MACD Chart
Last Friday’s 610 DJIA point plunge (–3.4%) was the worst day of 2016 (3) and the worst loss since August 24, 2015. S&P 500 shed 3.6% on that day and was also its worst day of 2016. NASDAQ dropped 4.1% and you have to go all the way back to August 2011 to find a worse NASDAQ day.
Friday’s declines spilled over to Monday, triggering the fifth Down Friday/Down Monday of 2016 (4). No matter how these occurrences are analyzed, the result is ominous with DJIA frequently lower sometime during the next 90 calendar days. Sometimes the declines are nearly immediate while other time there will be a bounce first. DJIA’s streak of four straight down Friday’s (4) also confirms that traders and investors are reluctant to hold long positions over the weekend. This is either because summer is here and/or a lack of confidence in the market.
After three straight weeks of gains, S&P 500 (5) and NASDAQ (6) were down three consecutive weeks. As of today the market is on track to break this streak, but typical first-trading-day-of-July strength falling on the Friday before the long holiday weekend could be a catalyst for profit taking this year.
NYSE Weekly Advancers and Decliners (7) over the last three weeks confirm weakness, but have not reached the grossly lopsided values usually seen at or near major market bottoms. Because the lows from February and/or last August were not breached during the recent market retreat, NYSE Weekly New Highs and Lows (8) are also not at extremes. New index highs or lows would likely be needed to see any meaningful move in these metrics.
Weekly CBOE Put/Call (9) climbed to 0.74 last week from a 0.59 reading at the end of May. The steady trend higher is concerning as it would seem to indicate that traders do not believe the worst is over yet. This week’s reading is on a course lower which would be welcome.
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