Financial Review

Super Low

Sinclair Noe — July 7, 2016

Podcast: Play in new window | Download (Duration: 13:16 — 6.1MB)

Subscribe: iTunes | Android | RSS

DOW – 22 = 17,895
SPX – 1 = 2097
NAS + 17 = 4876
10 Y + .02 = 1.39%
OIL – 2.23 = 45.20
GOLD – 3.40 = 1360.80

The Fed didn’t raise its benchmark interest rate last month because officials worried about the “surprisingly weak May employment report,” according to the minutes of the June meeting. And that was before the Brexit vote. The minutes offered no guidance on when the Fed might raise interest rates. Of course, the May jobs report showed just 38,000 net new jobs.

Tomorrow morning, we will find out how many jobs the economy added in June; consensus estimates are around 175,000; something close to that number and we can look at May as an aberration. A repeat of May, or worse, and we have serious problems. This morning we got a couple of reports that might offer clues to tomorrow’s report.

ADP reported that 172,000 private-sector jobs were added in June, above economists’ expectations for a gain of 150,000 jobs. According to ADP, small private-sector businesses added 95,000 jobs in June, medium businesses added 52,000 and large businesses added 25,000. All of those gains were in the service sector—208,000 jobs were added there, compared with a loss of 36,000 for goods producers. The manufacturing sector lost 21,000 jobs in June.

Initial claims for unemployment benefits fell by 16,000 last week to a nearly three-month low of 254,000. Layoffs have remained extremely low even though hiring tapered off in the early spring.

Bond yields are really low. Yesterday, the yield on the 10-year note hit 1.37%. Researchers at Global Financial Data checked monthly long term bond yields stretching all the way back to 1786. Based upon 230 years of data, they conclude that interest rates in the US have hit the lowest levels ever. So is this good or bad news? If you have solid credit and a decent job and you’re looking to get a mortgage and buy a house, or refinance a mortgage, this is incredibly good news.

The 30-year fixed-rate mortgage followed Treasury yields, falling seven basis points to 3.41% in this week’s survey. Mortgage rates have now dropped 15 basis points over the past two weeks, leaving them only 10 basis points above the all-time low. As a result, home loan volume is soaring. The Mortgage Bankers Association reports mortgage applications rose 14.2% over the previous week, in a survey ending July 1. Refinance application volume jumped almost 21% last week to its highest level since January 2015.

If you’re a well-run company looking to borrow and expand, again, this historic low interest rate environment is good news. The same goes for governments who want to borrow and invest in costly infrastructure projects that pay dividends over time.

On the other hand, if you are a bank or financial institution that makes your money on the spread between borrowing short term and lending long term, this is making life more difficult. Likewise, if you’re an insurance company trying to buy long-term bonds that pay you enough of a return to match the claims customers will make on you decades in the future, this is a very difficult environment.

Danone, the world’s largest yogurt maker, has agreed to buy U.S. health group WhiteWave Foods in what would be the French company’s largest acquisition in 10 years. The offer equates to $56.25 per share in cash, resulting in an enterprise value of around $12.5 billion, and would double the size of Danone’s U.S. business.

Avast Software has agreed to buy AVG Technologies for $1.3 billion in cash to expand its geographical reach, internet security opportunities and tap into newer areas such as Internet of Things. Avast, which provides free and paid software for personal computers and mobile devices, has more than 230 million users worldwide.

Burger chain Wendy’s says that a malware it had found at some franchisees in June had enabled hackers to access payment card information from the point-of-sales systems. The company said hackers targeted cardholder names, card numbers and the three-digit card verification value number found on the back of cards.

Since the start of 2016, 20 of the world’s bigger banks have lost a quarter of their combined market value, or about $465 billion, according to FactSet data. They have been losing value since the start of the year, and the Brexit vote was just salt on a wound. The biggest market-value losers, in dollar terms, so far this year: Italy’s UniCredit has lost nearly two-thirds of its value; Royal Bank of Scotland has fallen around 56%; and Credit Suisse, Deutsche Bank and Barclays have all about halved. UniCredit trades at about 21% of book value. Deutsche Bank trades at about 26%, or where it was during the darkest days of the financial crisis.

That means some of these banks are either a bargain or there are legitimate concerns about their viability. Deutsche Bank, Germany’s largest bank, now has a market value that in dollar terms is less than that of SunTrust Banks, the regional U.S. bank focused on the Southeast. And the market values of UniCredit, Deutsche Bank and Credit Suisse combined wouldn’t equal that of Goldman Sachs – itself down about 20% this year.

One of the hardest hit Euro banks is not in the top 20 globally but it is the oldest bank in the world; Banca Monte dei Paschi di Sienna is down 80 percent in the last 12 months. Its shares also trade at under 10 percent of its book value — a measure of its net worth — a sign that investors really think that the bank needs new capital. Also, when bank stocks sink that much, banks find it almost impossible to raise new capital in the markets. The good news is that it is not a megabank, and it is not heavily involved in derivatives trading – it just has a bunch of bad loans. Italy’s banks, including Monte dei Paschi, have about $222 billion of bad loans, and they need about $45 billion in bailouts or bail-ins.

But such a bailout may be illegal under relatively new European rules that aim to protect taxpayers and instead force investors in the banks to provide financial support in times of trouble. Investors lend money to banks by buying their debt securities. Under the anti-bailout rules, those securities would be forcibly turned from debt into new equity, which could absorb any new losses taken on the bad loans. Under such a so-called bail-in, the equity would in theory be worth less than the debt securities, leading to losses for investors who held the debt. The problem with bail-ins is that retail investors take a hit, they stop investing, they stop depositing, they start withdrawing; and before you can blink there is a run on the bank.

The pound sterling, at about $1.2924, has dropped to its lowest level since 1985. If you were ever thinking about a vacation in London, now might be the time. An average round-trip fare from US airports into London was $687.36 by July 3, according to airfare-tracker Hopper. That’s a 14% drop since the Brexit vote, and the lowest fares in 3 years. It might not last. Online searches for flights to the UK are up 60% in the past 2 weeks.

Boeing is stepping up efforts to conserve cash, cut costs in its supply chain and trim inventory of parts in its factories, and relying on suppliers to hold parts instead. Boeing is also telling vendors it will take longer to pay bills; up to 120 days to pay, rather than 30 days in the past.

A House panel will debate legislation today that could block a $17.6 billion sale by Boeing to Iran Air. Three measures will be considered, including one preventing the Treasury from licensing the sale, another stopping transactions tied to aircraft export and a third barring the Ex-Im Bank from providing financing for deals with the Islamic Republic. New laws would affect Airbus as well as other firms, since virtually all modern jets have more than 10% U.S. content and require export licenses.

The U.S. government proposed eight airlines to begin scheduled passenger service to Havana, Cuba. Flights could begin as early as this fall. The airlines winning approval for Havana service were American, Delta, United, Southwest, Spirit, Alaska, Frontier and JetBlue.

If you fly, you know that there is a big problem at almost all airports: the TSA screening process. American Airlines is trying to do something about it. They are teaming up with the Transportation Safety Administration to deploy CT technology for carry-on bags and install automated screening lanes. CT, or computed tomography, is a 3D imaging technology that’s widely deployed in the medical field. Although the technology has been around for more than a decade, only now has the TSA decided to put it into use.

The airline will adopt CT technology in a trial program at security checkpoints located in its Phoenix Sky Harbor International Airport hub. Although, CT scanning tech is currently in use for checked baggage, American will be the first US airline to deploy the system for carry-on bags. When applied to the security lane, a CT scanner allows customers to leave their liquids, gels and aerosols, as well as laptops, in their carry-on bags. American Airlines and the TSA expect the Phoenix CT checkpoint scanners to be up and running by the end of the year and could spread to other airports around the country if the trial is successful.

The new security lanes will feature automated conveyor belts to move storage bins between the X-ray machines and the end of the queue. In addition, the bins themselves are 25% larger. There will also be cameras installed to take pictures of the exterior of bags to go along with the X-ray images of its contents. Both parties believe the new lanes, which are expected to come online this fall, will decrease wait times by as much as 30%.

Financial Review

How Low Can It Go?

Sinclair Noe — July 5, 2016

Podcast: Play in new window | Download (Duration: 13:16 — 6.1MB)

Subscribe: iTunes | Android | RSS

DOW – 108 = 17,840
SPX – 14 = 2088
NAS – 39 = 4822
10 Y – .09 = 1.36
OIL – 2.39 = 46.60
GOLD + 5.70 = 1357.20

Longer-end Treasury yields traded near record lows, with the 30-year yield around 2.15 percent. The 10-year yield dropped to an all-time low of 1.367 percent.

The U.S. dollar index posted another gain to 96.28, with the euro around $1.11 and the pound sterling traded near $1.30, levels not seen in more than 30 years. European stocks were mostly lower, with the German DAX off more than 1.5 percent. The STOXX Europe 600 Banks index under-performed, trading about 2 percent lower.

Factory orders in the U.S. fell 1% in May after two straight gains. So far this year, orders for manufactured goods have dropped 1.9 percent to $2.2 trillion compared to the same period in 2015.

Demand in a category that serves as a proxy for business investment – non-military goods that exclude the volatile aircraft category – slipped 0.4 percent in May. The Commerce Department also reports durable goods orders declined 2.3%.

Demand for mining and energy-related equipment slid 5.8% following a 20.8% plunge in the prior month. Orders for computers were also weaker. Bookings for nondurable goods rose 0.3%.

Corelogic reports home prices nationwide, including distressed sales, increased year over year by 5.9 percent in May 2016 compared with May 2015 and increased month over month by 1.3 percent in May 2016 compared with April 2016.

The CoreLogic HPI Forecast indicates that home prices will increase by 5.3 percent on a year-over-year basis from May 2016 to May 2017 – so more of the same. Twenty-two states reached new highs for the month; Arizona was not one of them; we remain 23.9% below peak prices, but the state did record a 5.8% year-over-year price increase.

Tomorrow we get the minutes from the Fed’s June FOMC meeting. If the minutes show real concerns about the durability of the economy, it could be friendly to the dovish market, which now only has fully priced in the next rate hike in 2018. Alternatively, the minutes could suggest the Fed was fairly confident that the labor market would come back. This would be less friendly for the market.

Federal Reserve Bank of San Francisco President John Williams held a couple of interviews today and said Britain’s vote to exit the European Union probably won’t derail the U.S. economy, leaving the Fed scope to raise interest rates this year if his growth and inflation expectations are met.

The Bank of England takes action. The BOE’s Financial Policy Committee cut its counter-cyclical capital buffer for UK banks to zero from 0.50%, according to the latest Financial Stability Report. The committee says the buffer will remain in place for at least the next year as the UK economy deals with “uncertainty” following the vote for a British exit from the European Union, or Brexit.

Australia’s central bank held its cash rate today at a record low of 1.75%, a widely expected decision given political uncertainty and a lack of timely information on domestic inflation. The country still doesn’t know who won Saturday’s general election and final results may not be known for another week.

Euro zone business growth held steady in June, but the modest pace suggested economic growth in the second quarter was half the rate of January-March, even as a rebound in Italy and rapid acceleration in Spain brightened the outlook. In France, data showed both services and manufacturing contracting. The majority of the surveys were completed before Britain voted on June 23 to leave the European Union.

In the past 24 hours, three different UK property funds have frozen withdrawals, citing a rush by investors to pull out their money in the wake of the UK’s Brexit vote. In 2007, Bear Stearns banned withdrawals from one of its hedge funds after investors were spooked by rising defaults and bankruptcies. The British property funds are very different beasts from the exotic, derivative-laced vehicles that presaged the global financial meltdown. These funds are open to regular retail investors and invest in things like office parks and malls.

But forget about Brexit for a moment; the new worry of the day is Italian banks. A big feature from The Wall Street Journal  captures most of the concerns with Italy’s banking system and the political turmoil it appears liable to set off.

In short, Italian banks are loaded with bad debts; 17% of bank loans in Italy are “sour,” a level much greater even than that of the US banking system at the height of the financial crisis (5%).Of course, issues surrounding the Italian banking system are not strictly new, and in the past year shares of UniCredit — Italy’s only bank considered globally significant — and Banca Monte dei Paschi di Siena, the oldest bank in the world, are down over 60%.

Reports surfaced in April that the government could step in to shore up the banking system; days later the government got executives, insurers, and investors to put 5 billion euros into a rescue fund for Italy’s weakest banks. This morning, a report from Bloomberg said Italy was looking to inject up to 3 billion euros into Monte dei Paschi; this would be the bank’s third bailout since the financial crisis.

The U.S. holds more oil reserves (264 billion barrels) than Saudi Arabia (212 billion) and Russia (256 billion), the first time it has surpassed those held by the world’s biggest exporting nations, according to a new study by Rystad Energy.

The analysis of 60,000 fields worldwide, conducted over a three-year period, shows total global oil reserves at 2.1 trillion barrels. That is 70-times the current production rate of about 30 billion barrels of crude per year. For the U.S. more than 50 percent of the remaining oil reserves is in unconventional shale oil. Today, oil prices dropped nearly 5%.

NASA’s Juno spacecraft, built by Lockheed Martin, ended a five-year, 1.8 billion-mile journey to Jupiter, with a do-or-die engine burn to sling itself into the planet’s orbit. No small trick. At the time of its arrival, Juno was flying through the solar system at over 150,000 miles per hour—making it one of the fastest man-made objects ever.

Juno will spend the next 20 months studying what lies beneath the gas giant’s thick clouds and measure its gravity, magnetic fields and water content. Juno is the ninth spacecraft to see Jupiter up close, but only the second to ever go into orbit around it, and Juno promises to provide the most intimate peek into the far-off Jovian system yet.

Poland has made significant progress in its talks with Raytheon over a Patriot missile system valued at an estimated €5-billion-euro. According to the Polish Defense Ministry, the country is ready to move ahead with the plan because Raytheon pledged that 50% of the missile system spending would be “done in Poland by Polish arms firms.”

BlackBerry will stop making its Classic smartphone. The Classic was launched early last year, with a physical keyboard and powered by the company’s overhauled BlackBerry 10 operating system. BlackBerry has since launched a phone powered by Alphabet’s Android software and plans several more.

Google DeepMind, the London-based artificial intelligence unit owned by Alphabet, announced a research partnership today with the British National Health Service to gain access to a million anonymous eye scans. DeepMind specializes in machine learning, the increasingly important area of technology where algorithms allow computers to learn and figure things out on their own.

DeepMind will use the eye scan data to train its computers to identify eye defects. The aim is to give doctors a digital tool that can read an eye-scan test and recognize problems faster. Earlier detection of eye disorders related to diabetes and age-related macular degeneration could allow doctors to prevent loss of vision in many people

A bidding war with Salesforce.com forced Microsoft to pay nearly $6 billion extra last month to seal its planned takeover of LinkedIn. Details of the frenzied bidding were revealed in a filing with the SEC ahead of a shareholder vote to approve the transaction. A month-long back-and-forth between the two rivals pushed the value of the all-cash deal to $26.2 billion, making it the third-largest acquisition in the tech industry.

Three former Barclays traders have been found guilty of Libor manipulation almost four years after the bank paid out hundreds of millions of dollars in fines for fixing the key benchmark rate. Days after the British firm became the first to settle, its Chief Executive Officer, Bob Diamond, lost his job and regulators eventually imposed roughly $9 billion in penalties on the financial industry.

The convictions bring the total number of bankers Britain has convicted over the long-running Libor-rigging scandal to five. That is still a better fines to conviction ratio by far than the US had for mortgage abuses by big banks.

London Stock Exchange shareholders approved a $27 billion merger with Deutsche Boerse yesterday despite renewed uncertainty following the Brexit vote. The two exchanges insisted that their all-share merger to create the world’s biggest bourse by revenue was essentially “Brexit proof”.

Downside Volatility Continues to Start Week

Charles Schwab: On the Market

Posted: 6/27/2016 4:15 PM ET

Downside Volatility Continues to Start Week

U.S. stocks continued Friday's sell-off in the aftermath of the U.K.'s vote to leave the European Union, with financials and technology issues responsible for the brunt of the decline. Treasury yields continued lose ground, while a preliminary read on services sector activity was unchanged from the previous month and some regional manufacturing data remained in contraction territory. The U.S. dollar surged to the upside and gold was also higher, while crude oil prices were lower.

The Dow Jones Industrial Average (DJIA) fell 261 points (1.5%) to 17,140, the S&P 500 Index lost 37 points (1.8%) to 2,001, and the Nasdaq Composite tumbled 114 points (2.4%) to 4,594. In heavy volume, 1.3 billion shares were traded on the NYSE and 2.6 billion shares changed hands on the Nasdaq. WTI crude oil dropped $1.31 to $46.33 per barrel and wholesale gasoline was $0.04 lower at $1.53 per gallon, while the Bloomberg gold spot price rose $10.89 to $1,326.64 per ounce. Elsewhere, the Dollar Index—a comparison of the U.S. dollar to six major world currencies—jumped 1.1% to 96.48.

Medtronic PLC (MDT $82) inked a deal to acquire circulatory support technology firm Heartware International Inc. (HTWR $58) in a transaction valued at $1.1 billion. As part of the agreement, MDT will pay $58 per share in cash for each share of HTWR, a 93% premium to Friday's closing price, with the purchase expected to close by the end of October. Shares of MDT closed lower, while HTWR rallied over 90%.

Preliminary services sector read unchanged, regional manufacturing remains in contraction

The preliminary Markit U.S. Services PMI Index in June was unchanged from May's final reading of 51.3, with a level above 50 indicating expansion in activity, and compared to the Bloomberg forecast calling for a modest rise to 52.0. The release is independent and differs from the Institute for Supply Management's (ISM) report, as it has less historic value and Markit weights its index components differently.

The Dallas Fed Manufacturing Index ticked slightly higher to -18.3 for June from May's unrevised -20.8 level with economists forecasting an improvement to -15.0. A reading below zero denotes contraction.

Treasuries were decidedly higher, with uncertainty remaining after Friday's Brexit vote as the yield on the 2-year note fell 3 basis points (bps) to 0.60%, the yield on the 10-year note declined 10 bps to 1.46%, and the 30-year bond rate decreased 13 bps to 2.28%. For the latest analysis on the bond markets, see Schwab's Chief Fixed Income Strategist, Kathy Jones' recent article titled Brexit: What Does It Mean for the Bond Market?, at www.schwab.com/marketinsight. You can also follow Kathy on Twitter: @kathyjones.

Tomorrow, the U.S. economic calendar will commence with the release of the third and final reading of 1Q GDP, with economic output expected to have ticked higher to a 1.0% quarter/quarter (q/q) annualized rate of expansion, from the 0.8% pace announced in the second release, while personal consumption is expected to be adjusted higher from a 1.9% to a 2.0% q/q increase. Investors will also get a look at the S&P/CaseShiller Home Price Index, forecasted to show home prices in the 20-city composite rose 5.41% y/y during April, and were 0.58% higher m/m on a seasonally-adjusted basis. Finally, after the opening bell, the Consumer Confidence Index and Richmond Fed Manufacturing Index are scheduled for release.

Brexit fallout continued to weigh on Europe, Asia mostly higher despite yen strength

European equities finished lower, extending the severe losses seen last Friday in the wake of the U.K.'s stunning vote to leave the European Union (EU)—known as a Brexit—that sent shockwaves through the global markets with U.K. banks taking the brunt of the burden. Adding to the uncertainty, Scottish First Minister Sturgeon said that a second independence referendum for Scotland was "very much on the table." For the latest on the markets, Schwab's outlook, and other considerations surrounding Brexit, Schwab offers a number of articles for investors to consider, including the latest Schwab Market Perspective: British Shock—What's Next, at www.schwab.com/marketinsight. You can also follow Schwab and on Twitter: @schwabresearch.

U.K. Chancellor Osborne delivered a speech ahead of the market's open in an attempt to calm nerves, saying that despite the uncertainty, "you should not underestimate our resolve" in navigating the unchartered waters ahead. Meanwhile, later in the day in speaking to Parliament, Prime Minister Cameron rejected pleas for a "do-over" Brexit vote, instead appointing a group of officials to prepare for the withdrawal from the EU. The Conservative Party also accelerated the timeframe for a new leader, pulling the timetable back by nearly a month to September 2. For in depth analysis of the issue, as well as what is next, see Schwab's Chief Global Investment Strategist, Jeffrey Kleintop's, CFA, timely article After the Brexit Vote: What Lies Ahead for Markets?, at www.schwab.com/marketinsight, and be sure to follow Jeff on Twitter: @jeffreykleintop. The British pound was lower, adding to its record loss on Friday, and the euro saw pressure versus the U.S. dollar, while bond yields in the region were lower.

Stocks in Asia finished mostly higher, being the first to "dip its toe" in the uncertainty of the aftermath of Friday's severe rout in the wake of the decision by the U.K. to quit the European Union. Japanese equities rallied, despite the yen showing strength, and after an emergency meeting between Japanese policymakers. Prime Minister Abe, Finance Minister Aso and Bank of Japan (BoJ) deputy governor Nakasone concluded their meeting without any substantive moves, but with a pledge to act if necessary, fueling speculation of some sort of intervention by the BoJ with either more stimulus, a BoJ easing, or a combination of the sort. Mainland Chinese stocks advanced and those trading in Hong Kong were flat, with Premier Li saying despite the risks of the Brexit fallout, he still expects to achieve their growth targets. Finally, strength in materials helped Australian securities tick higher, while listings in South Korea and India were both nearly unchanged.

Tomorrow, the international economic docket will be light, offering the Import Price Index from Germany and consumer confidence from France, Italy and South Korea.

Financial Review

A Post-Brexit World

Sinclair Noe — June 24, 2016

Podcast: Play in new window | Download (Duration: 13:16 — 6.1MB)

Subscribe: iTunes | Android | RSS

DOW – 610 = 17,400
SPX – 75 = 2037
NAS – 202 = 4707
10 Y – .17 = 1.57%
OIL – 2.49 = 47.62
GOLD + 59.30 = 1316.60

Britain has voted to leave the European Union, forcing the resignation of Prime Minister David Cameron. Global financial markets plunged. The pound fell more than 10 percent against the dollar at one point to touch levels last seen in 1985, on fears the decision could hit investment in the world’s fifth-largest economy, threaten London’s role as a global financial capital and usher in months of political uncertainty. The pound finished down almost 8%. The euro slid 3 percent. Those are huge moves for currencies.

World stocks saw more than $2 trillion wiped off their value, with indices across Europe heading for their sharpest one-day drops ever; the Nikkei 225 fell nearly 8 percent and the German DAX traded 6.8 percent lower; the CAC 40 in France down 8 percent; Italy down 11.5 percent. By contrast the FTSE 100 in Britain was down 3.1 percent.

Britain’s big banks took a $100 billion battering, with Lloyds, Barclays and RBS plunging as much as 30 percent at one point. Goldman Sachs, JPMorgan, and BofA closed down around 7%, while Citigroup lost almost 10%. Ten-year U.S. Treasury note yields hit a low of 1.406 percent, its lowest since July 26, 2012, before bonds started paring gains. The 2-year yield hit a low of 0.499 percent, its lowest level since April 17, 2015. The German 10-year bund yield fell back into negative territory. Gold hit its highest in more than 2 years around $1331 an ounce.

Last night, as the results were first coming out, waves of selling in stock futures sent S&P 500 indexes on the Chicago Mercantile Exchange into a limit-down trading curb. The rules were triggered when S&P 500 contracts declined 5 percent from the previous day’s close. E-mini futures plunged 5.07 percent to 1,999. After the first strong reactions, prices have started to shake out and settle.

The U.S. Federal Reserve, already undecided on when next to raise interest rates, now has one more reason to wait. Not that the Fed needed another reason. Weaker-than-expected growth in U.S. jobs in recent months had already forced U.S. central bankers to put off a rate hike at their meeting last week. But while data due early next month on June U.S. payrolls growth could help clear up doubts about the strength of the labor market, the political and economic consequences of Britain’s exit from the EU will take months or years to unfold. Interest rate futures markets rallied so hard that they have erased any probability of an increase in the Fed’s benchmark overnight lending rate for both this year and next. In fact, they are pricing a possibility that the federal funds target rate may be lower in September or December.

The Bank of England said it would take all necessary steps to shield Britain’s economy from financial shock. The economy was already slowing as the referendum approached and BoE Governor Mark Carney said in May that it could suffer a technical recession — a contraction in two consecutive quarters. Carney said earlier this year that a Brexit vote would also test the “kindness of strangers” who fund the country’s big current account deficit. The BoE held two extra liquidity auctions ahead of the referendum and is due to hold another one on Tuesday in order to help banks.

As time passes, and the financial markets calm down after the voting, Britain will still be dealing with the economic fallout of this decision. It hardly seems a good time for capital investment in the UK. Things like business confidence, market swings and central bank responses shape the economy in the short and medium run, but over time it is bigger forces that prevail. And this is where there is the most uncertainty of all. The UK could break up over this decision. Nicola Sturgeon, Scotland’s first minister, said that a new referendum on independence in Scotland was “highly likely” now that Britain has voted to leave the EU. Sinn Fein has asked for a vote in Northern Ireland to join Ireland.

There are now many questioning whether the EU will fall apart. And the Eurozone has already been experiencing stagnation, with extreme weakness – actually a depression in Greece, and something very near depression in Spain and Portugal and Italy. What holds these countries to the Euro union? Promises of more austerity and privatization? Even the Dutch are talking about leaving. It seems clear that the European project – the whole effort to promote peace and growing political union through economic integration – is in deep, deep trouble. Brexit is probably just the beginning.

Nothing will happen fast. Prime Minister David Cameron said he would leave office by October. Cameron led the “Remain” campaign to defeat. Cameron has been premier for six years and called the referendum three years ago, in a bid to head off pressure from domestic eurosceptics.

The EU was poorly designed, having put the monetary cart ahead of the political horse. Lacking a well-articulated federal structure, power has devolved to bureaucrats and German bankers. Considering that Europe responded poorly to the financial crisis, in retrospect Cameron’s referendum suffered from spectacularly bad timing. He asked British voters to invest in a vehicle which is broken down beside the road.

The UK exit will take at least two years, maybe longer, under Article 50, which is the exit clause. Cameron will likely try to negotiate some sort of transition but another option is to just leave immediately. While holding-off on invoking the Article 50 clause to deprive the EU of leverage on timing. Any unilateral steps would seriously raise tensions with the EU. Brussels is looking at options to retaliate, including suspending the privileges enjoyed by British companies under the single market; making an example for other would-be insurgents. Meanwhile, Germany will likely have a harsh response.

If the Brits thought they could have a nice friendly divorce, and live like Switzerland or Norway; don’t count on it. Remember when Greece’s finance minister Varoufakis tried to negotiate terms with the EU? This is likely to be a brass knuckles brawl. Even before this, UK negotiators in Europe were almost universally despised by their European counterparts. I suspect lots of old scores will be settled.

Meanwhile, London is a financial hub for the Eurozone, thanks in part to passport agreements that allow financial services to be sold across Europe from the UK. Anyone actually buying and selling securities—the banks’ trading desks—are definitely affected and many may need to move to the Continent. For the time it takes to negotiate and exit, the UK and its financial sector remains subject to all European rules and agreements. That is one thing that can be said for sure. The other is that this sector faces great upheaval and high costs as it works out where and how it can continue to pursue its businesses.

The British government is likely to lose its AAA rating, which also means higher funding costs for its banks, since their borrowing rates are at a premium to the local currency risk-free rate. A recession is almost certain, since the UK exports services and imports goods and many of its imports don’t have ready substitutes, while the US and European banks will be doing everything they can to poach both British bankers and their clients, denting the UK balance of trade even more.

The sterling crisis and the less dramatic fall in the euro are likely to leave some UK and Eurozone financial institutions with large losses on net dollar and other foreign currency positions. While the British banks, given the magnitude of the sterling plunge, are the obvious focus of concern, many Eurobanks are undercapitalized. Worse, the Eurozone in theory will use a bank bail-in if any institution becomes impaired. This is a prescription for bank runs.

And with the US growth sputtering, our economy will feel the effects. Roughly 25% of S&P earnings come from Europe. The strong dollar will weigh on exporters. Europe is a major export market for China, and China may allow the renminbi to slide. Earlier this year, a devaluation of the renminbi was also seen as having the potential to trigger major upheaval. And throw in one more point, The Transatlantic Trade and Investment Partnership is probably dead.

This is the first day off the post-Brexit vote, but just the beginning of the Brexit problem. There will probably be a great deal of volatility in the coming weeks and months. I wish I could tell you one side or the other was right or wrong, but this has never happened before; this is new territory and we don’t know what happens next, good or bad. Keep calm and carry on.

We have a couple of economic reports here in the US. Consumer sentiment weakened in June; the University of Michigan index dropped in June to 93.5 from 94.7 in May. That was also well below its level a year ago, when it touched 96.1. Consumers were more bearish about expectations for the economy. That gauge fell to 82.4 from 84.9. Views of current conditions perked up, rising to 110.8 from 109.9.

U.S.-made durable goods orders fell a seasonally adjusted 2.2% last month after a revised 3.3% gain in April. Core capital orders sank 0.7% in May, a sign that companies are still not investing as much as they normally do when the economy is growing. This key reading has been down five of the last seven months.

Just a week before about $2 billion in bond payments come due, Puerto Rico’s governor has reiterated that the commonwealth will default on its general obligations even if he halted services on the island. Alejandro Garcia Padilla is currently in Washington lobbying for Congressional approval of a bill that would set up a framework for the commonwealth to restructure its $70 billion in debt.

Stocks Go So Low as U.K. Sets To Depart EU

Charles Schwab: On the Market

Posted: 6/24/2016 4:15 PM ET

Stocks Go So Low as U.K. Sets To Depart EU

U.S. stocks erased 2016's gains, joining a global rout for equities and the British pound traded to lows not seen in more than 30 years in the wake of the U.K. voting to leave the European Union. Financial and Technology stocks were the largest decliners, while the aftermath of the Brexit vote made it difficult to assess the possible market impact of lower-than-expected reads on domestic durable goods orders and consumer sentiment. Treasuries, gold and the U.S. dollar rallied and crude oil prices experienced a large, sharp drop.

The Dow Jones Industrial Average (DJIA) tumbled 611 points (3.4%) to 17,400, the S&P 500 Index fell 76 points (3.6%) to 2,037, and the Nasdaq Composite plummeted 202 points (4.1%) to 4,708. In heavy volume, 2.5 billion shares were traded on the NYSE and 3.8 billion shares changed hands on the Nasdaq. WTI crude oil dropped $2.47 to $47.64 per barrel and wholesale gasoline was $0.07 lower at $1.54 per gallon, while the Bloomberg gold spot price rallied $62.56 to $1,319.41 per ounce. Elsewhere, the Dollar Index—a comparison of the U.S. dollar to six major world currencies—jumped 2.1% to 95.50. Markets were lower for the week, as the DJIA and the S&P 500 Index decreased 1.6% and the Nasdaq Composite fell 1.9%.

Xerox Corp. (XRX $9) announced Jeff Jacobson will be the company's new Chief Executive Officer once the organization divides into two separate publicly-traded companies. The document solutions company said the split remains on track for the end of the year. Earlier in the month, XRX named Ashok Vemuri as the CEO of the smaller of the two companies, which will be named Conduent. XRX lost ground.

Sonic Corp. (SONC $28) posted fiscal 3Q EPS ex-items of $0.43, a penny above the FactSet estimate, as revenues rose 18.0% y/y to $165.2 million, compared to the projected $164.7 million. Same-store sales rose 2.0% year-over-year, below analysts' view of a 2.4% y/y increase. The drive-in burger chain said it now expects same-store sales for the year to increase 2%-4%, below previous projections of 6%, but it maintained its earnings growth forecast of 20%-25%. Shares closed sharply lower.

Durable goods orders lower than forecasts, consumer sentiment ticks lower

May preliminary durable goods orders (chart) fell 2.2% month-over-month (m/m), compared to Bloomberg's estimate of a 0.8% decline and April's upwardly revised 3.3% gain. Ex-transportation, orders declined 0.3% m/m, versus the 0.1% forecasted increase, and April's unrevised 0.5% gain. Orders for non-defense capital goods excluding aircraft, considered a proxy for business spending, declined 0.7%, compared to projections of a 0.4% increase, and following the upwardly revised 0.4% dip in the month prior.

The final June University of Michigan Consumer Sentiment Index (chart) was revised to 93.5 from the preliminary level of 94.3, and compared to expectations of a slight dip to 94.1, as the expectations and current conditions components of the report were both revised downward. The index was also lower compared to May's level of 94.7, where it sat at the highest level since June 2015. The 1-year inflation outlook rose to 2.6%, from May's 2.8% rate. The 5-10 year inflation forecast also moved higher to 2.6% from May's 2.3% level.

Treasuries were decidedly higher, with the yields on the 2-year note and the 30-year bond falling 13 basis points (bps) to 0.64% and 2.43%, respectively, while the yield on the 10-year note lost 17 bps to 1.57%. For our latest analysis on the bond markets see the article by Schwab's Chief Fixed Income Strategist, Kathy Jones, titled Global Bonds: A World Without Yield, at www.schwab.com/marketinsight, while you can also follow Kathy on Twitter: @kathyjones.

U.K. vote shocks world, markets in Europe and Asia plunge

European equities finished deep in the red, after the U.K.'s stunning vote to leave the European Union (EU)—known as a Brexit—after four decades sent shockwaves through the global markets—a complete about-face from yesterday's optimism that the U.K. would vote to remain in the EU. The final vote tally was 52% for an exit, 48% against—a close election, as many had expected, however not the outcome that investors had banked on yesterday. In the wake of the results, Prime Minister David Cameron stepped down, saying, "The British people have made a very clear decision to take a different path, and as such I think the country requires fresh leadership." Cameron said he will remain at 10 Downing Street for the next three months, with a new Conservative leader to be appointed by October.

Financials were in the eye of the storm, with the European bank index falling the most ever, while the British pound tumbled to touch a level not seen in over 30 years. Amidst the turmoil, and following Cameron's announcement, Bank of England (BoE) Governor Carney issued an early-morning statement, saying the BoE will pledge 250 billion pounds ($345 billion) to the financial system in what he called, "a period of uncertainty and adjustment." The BoE had previously supplemented funding auctions this month for lenders. Meanwhile, central banks across the globe have shifted to crisis-management mode, as the Swiss National Bank intervened in order to prevent a surge in the franc, the European Central Bank (ECB) said it stands ready to provide liquidity in euros or other currencies, and Bank of Japan Governor Kuroda said the central bank will do its best to provide cash.

Schwab's Chief Global Investment Strategist, Jeffrey Kleintop, CFA, offers in depth analysis of the vote in his timely article After the Brexit Vote: What Lies Ahead for Markets?, at www.schwab.com/marketinsight, and be sure to follow Jeff on Twitter: @jeffreykleintop. Economic news in the region took a backseat to the developments surrounding the Brexit, with France's final GDP data unrevised from previous reports, Italy's retail sales rising less than expectations and Germany's Ifo Business Climate Index was slightly better than forecasts. The euro pared solid early losses, but did finish firmly lower versus the U.S. dollar, while bond yields in the region were negative.

Stocks in Asia finished sharply lower, being the first to react to the decision by the U.K. to quit the European Union, with Japanese equities posting their largest decline in more than 15 years, and triggering a circuit-breaker on Nikkei futures. Japan's Nikkei 225 Index tumbled 7.9%, with the yen surging against its foreign counterparts. Stocks in mainland China lost ground, but were somewhat insulated from the fray after policymakers in the nation championed their management of corporate debt, saying that defaults would not pose a systemic threat as long as the economy continues to be within an acceptable range. Meanwhile, securities trading in Hong Kong snapped a five-session winning streak, while equities in Australia, India and South Korea were sharply lower.

The U.K. has left the building

Stocks finished lower for the week as gains were wiped out early Friday morning on the heels of the U.K.'s highly anticipated vote, where it decided it will exit the European Union. As noted in the recent Schwab Market Perspective: British Shock—What's Next, Britain shocked the financial community and global equity markets plunged as traders searched for perceived safety in the midst of uncertainty. Since the end of the financial-crisis induced global recession in 2009, a series of shocks have helped to keep growth, inflation and stock market performance subdued. The shocks that have taken place in Japan, United States, and Europe may offer us some insight as to the potential duration of the market impact of Brexit. Read more at www.schwab.com/marketinsight.

The added uncertainty from the long awaited Brexit vote seemed to disproportionately increase the volatility in the financials sector. Schwab's Director of Market and Sector Analysis, Brad Sorensen, CFA, takes a deeper dive into some of the factors that most influence the performance of this sector in his recent Schwab Sector Views: Financials: Danger or Opportunity?. Brad notes that the financials sector has been under attack by politicians and unloved by investors since the financial crisis, resulting in some very volatile performance. He also hints at the heavy regulatory burden placed on the financials sector over the past several years. But there are some glimmers of hope here as well. Despite the heated political rhetoric being leveled against the financials sector, there does seem to be an increasing realization that the regulations may have gone too far and had unintended consequences. Read more at www.schwab.com/marketinsight and follow Schwab on Twitter: @schwabresearch.

Heavy dose of manufacturing data ahead

Next week, the U.S. economic calendar will deliver a look at the health of the manufacturing sector of the economy with the release of the ISM Manufacturing Index, Markit's final Manufacturing PMI for June, the Richmond Fed Manufacturing Index and the Dallas Fed Manufacturing Index. Also, the third and final read for 1Q GDP will be released, with economic output expected to have ticked higher to a 1.0% quarter/quarter annualized rate of expansion, from the 0.8% pace announced in the second release.

Other U.S. reports slated for next week include: Markit's preliminary Composite PMI for June, the Chicago PMI Index, the S&P/Case-Schiller Home Price Index, the Consumer Confidence Index, pending home sales, personal income and spending, construction spending and vehicle sales.

Next week's international reports: Japan—retail sales, industrial production, CPI, vehicle production, housing starts and 2Q Tankan Index. China—manufacturing and non-manufacturing PMIs, industrial profits and the Leading Index. Hong Kong—retail sales and trade data. U.K.—1Q GDP, consumer credit and 1Q business investment. Germany—GfK Consumer Confidence, national and regional CPIs and retail sales. France—1Q GDP, PPI, CPI and consumer spending. Eurozone—consumer confidence and CPI.