Brexit: What Does It Mean for U.S. Corporate Credit?

By

Collin Martin

- June 28, 2016

Key Points

• The Brexit decision is likely to affect most types of investments, including U.S. corporate credit.
• High-yield bonds and preferred securities may be particularly vulnerable to price declines.
• Investment-grade corporate bonds should continue to make up a fixed income investor’s core portfolio holdings, in our view.

British voters’ decision to leave the European Union—commonly known as the “Brexit”—is likely to affect most types of investments, including U.S. corporate credit. In the hours after the Brexit vote, global investors focused on what they perceived to be the safest investments, and money flowed into U.S. Treasury securities. Performance was mixed for other investments, such as investment-grade corporate bonds, high-yield corporate bonds and preferred securities. Going forward, we think the Brexit decision will lead to more volatility in the fixed income markets, especially for those securities with higher credit risk.

Higher-rated investments performed relatively well on the day after the Brexit vote

Source: Bloomberg and Barclays. Barclays U.S. Treasury Index, Barclays U.S. Corporate Bond Index, Barclays U.S. Corporate High-Yield Bond Index, BofA Merrill Lynch Fixed Rate Preferred Securities Index, and S&P 500 Index. Total returns from market close on 6/23/16 through market close on 6/24/16. Returns assume reinvestment of dividends, interest, and capital gains. Indexes are unmanaged, do not incur fees or expenses, and cannot be invested in directly. Past performance is no indication of future results.

High-yield corporate bonds may be particularly volatile

During periods of heightened market volatility, investors often seek safe-haven investments such as U.S. Treasuries, while high-yield corporate bond prices have tended to suffer.¹ High-yield corporate bonds have a higher risk of default than investment-grade corporate bonds—that is, a higher probability that the issuer won’t be able to make scheduled debt payments, and in a worst-case scenario might not even return investors’ principal. Given that higher risk, they tend to perform poorly when economic conditions deteriorate.

The high-yield bond market also tends to have relatively low liquidity, a measure of the ease and price efficiency with which securities can be bought and sold. When investors seek safe havens in times of market stress and try to sell higher-risk investments, low liquidity could lead to large price fluctuations. Historically, the performance of high-yield corporate bonds has tended to be more correlated with U.S. equities than with U.S. Treasuries.² In other words, when stock markets fall, high-yield bond prices also tend to move down.

Another key risk for high-yield bonds is the market’s exposure to the price of oil. In the past few years, the percentage of bonds in the high-yield market issued by speculative-grade energy and natural resource companies has surged, to the point that energy sector issuers now make up nearly 14% of the Barclays U.S. Corporate High-Yield Bond Index. Lower prices mean less revenue and cash flow to pay creditors, heightening the risk that some companies could default on their debt. At the end of May, the trailing 12-month speculative-grade default rate had risen to 4.1%, compared with just 1.4% two years earlier.³

What does Brexit have to do with oil prices? It could affect two pressure points: the value of the U.S. dollar and the pace of global economic growth. In the two trading days after the June 23 Brexit vote the U.S. dollar rose by more than 3% compared with a broad basket of currencies, while the price of West Texas Intermediate crude oil dropped more than 7%. Most globally traded commodities, including oil, are priced in U.S. dollars. A stronger dollar makes these commodities more expensive for buyers who must convert their currency, even if the actual price of the commodity hasn’t changed, and commodity prices often move lower to offset that rise. Oil prices also tend to be sensitive to the ups and downs of the global economy, so if Brexit results in slower growth, oil prices could decline. While the price of oil had risen from lows reached this past January, stabilizing in the $40-$50 per barrel range during the previous two months, a further rise in the U.S. dollar could push the price lower.

High-yield bond prices have trended with the price of oil

Source: Federal Reserve Bank of St. Louis and Barclays. Crude Oil Prices: West Texas Intermediate – Cushing, Oklahoma and the Barclays U.S. Corporate High-Yield Bond Index. Daily data as of 6/27/16. Past performance is no guarantee of future results.

A credit spread is the difference between the yield on a corporate bond and the yield on a Treasury with a comparable maturity—it can be considered a premium for taking on the additional risk of a corporate bond. Although high-yield credit spreads are near their long-term average, we see risks ahead, including last week’s decision in the U.K. The Brexit decision will likely lead to more volatility and potential price declines, so we think it’s best for investors to stick with their long-term allocations to high-yield bonds, and not reach for yield if it’s not suitable for your risk tolerance.

Investment-grade corporate bonds: check your sectors

Investment-grade corporate bonds performed better than high-yield bonds immediately after the Brexit decision was announced, posting a positive return on June 24. Unlike high-yield bonds, investment-grade corporate bonds are more correlated with Treasuries than with stocks, so stock market volatility and declines doesn’t necessarily have the same effect on higher-rated bonds as on lower-rated ones.

The impact may be more significant in some sectors than others, however. We think the financials sector is one area of the investment-grade corporate bond market that may see more volatility. If the Brexit vote leads to slowdown in global growth, bank profitability often takes a hit because borrowing, from both businesses and consumers, tends to slow down. And many large U.S. banks earn a portion of their revenues from Europe—another potential hit to their profitability.
The Brexit vote has also led lower market expectations for further U.S. interest rate hikes, which can be a hindrance for banks as well. With yields so low, it’s difficult for banks to make much money on their loans. An ongoing near-zero interest rate environment may continue to weigh on bank performance. Overall, U.S. banks are in pretty good shape, however. Regulations put it place since the 2008 financial crisis are meant to keep the balance sheets more stable. Also, the Federal Reserve released on June 23 the first set of results from its most recent bank stress tests—all U.S. banks that were tested passed.

Investment-grade corporate bonds should continue to make up part of a fixed income investor’s core portfolio holdings, along with high-quality investments like Treasuries, in our view. While investment-grade corporate bonds may be more volatile than Treasuries in the short-term, volatility should remain lower than that of high-yield corporate bonds. But check your sectors—bonds issued by financial institutions could be more prone to price declines than those issued by companies in other sectors, such as utilities or industrials.

Preferred securities’ exposure to financial issuers may increase their volatility

Preferred securities could be volatile in the coming months not only because they share characteristics of both stocks and bonds, but because the market is dominated by financial institutions. Financial-institution issuers make up more than 70% of the BofA Merrill Lynch Fixed Rate Preferred Securities Index.

In the two trading days ending on June 27, the S&P 500^® Financials Index dropped by more than 8%, compared with a 5.3% decline in the broad S&P 500 Index. The preferreds market tends to move in the same direction as financial stocks, especially during periods of market volatility.

Preferred securities may act more like stocks than bonds during periods of market volatility

Source: Bloomberg. Daily data as of 6/27/16. Past performance is no guarantee of future results.

The average price of the preferred securities index only dropped 0.7% in the two trading days ending on June 27, but earlier this year the index was pulled sharply lower by the drop in financial stocks. And considering the average price of the index is close to its highest level in more than three years, and not much lower than its all-time high, there might be more downside than upside here. The direction of financial stocks will almost certainly spill over into how preferred securities perform in the second half of the year, in our view.

Investors looking for higher income opportunities should still consider preferred securities, but we expect plenty of volatility ahead. For investors with longer time horizons who can stomach large price fluctuations in exchange for the higher yields, preferreds may make sense. But for investors with shorter investment horizons who can’t handle large price swings, we’d recommend a more conservative investment approach and a focus on core fixed income holdings.

What to do now

Don’t reach for yield if you can’t stomach increased volatility. We expect heightened volatility, and potential price declines, in high-yield corporate bonds and preferred securities, meaning there may be better times to invest in the months to come. Investment-grade corporate bonds should be less volatile, and still make sense for investors’ core fixed income holdings, in our view.

¹ High-yield corporate bonds, also known as sub-investment-grade corporate bonds, carry ratings of Ba1 and below by Moody’s and BB+ and below by Standard & Poor’s.

² Correlation is a statistical measure of how investments move in relation to one another.

³ Standard & Poor’s, “The U.S. Speculative-Grade Corporate Default Rate Increased To 4.1% In May,” 6/1/2016. 

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.

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.

Brexit: What Does It Mean for the Bond Market?

By

Kathy A. Jones

- June 24, 2016

Key Points

• Britain's vote to leave the European Union has pushed down U.S. Treasury yields, as risk-averse investors have flocked to the perceived safety of U.S. government bonds.
• The Federal Reserve is now less likely to raise U.S. interest rates this year, and could even move for a rate cut.
• Market turmoil underscores the importance of high-quality bonds as the core of a portfolio.

On Thursday, the British electorate voted to leave the European Union, ending 43 years of participation. It was a surprise. The market had been persuaded by early polls that voters would choose to stay in the EU for economic reasons. But anti-EU sentiment in northern England and elsewhere outside London proved too strong, as voters used the referendum to express their anxiety about the effects of globalization, immigration and regulation on industry. Prime Minister David Cameron has already announced he will step down. Once the prime minister has invoked Article 50 of the Lisbon Treaty, there will be a window of two years to negotiate the exit and Britain’s future relationship with the EU.

So far, here's what we're seeing as markets absorb the news:

• U.S. Treasury yields are down as risk-averse investors have flocked to the perceived safety of U.S. government bonds. The 10-year yield is close to its 2012 low and the 30-year is back to the 1954 low of 2.37%. The market will probably scale back its expectations of a federal funds rate hike this year, and possibly build in expectations for a rate cut later in the year. I think a rate cut remains a very low probability, but the market will probably discount the possibility.
   
• Risk aversion has also driven investors to German bunds and Japanese bonds, which have seen their prices rise. Yields—which move inversely to prices—are well into negative territory stretching out to 10-year maturities. However, peripheral European bond spreads are widening because of concerns that other countries, such as Spain and Portugal, could choose to leave the EU.
   
• Credit spreads in the U.S. will probably widen. Based on credit default swap levels, it looks like energy and financials will be the hardest hit. The sharp rise in the U.S. dollar has sent commodity prices lower, while the financial sector has been hit because it is Britain’s largest industry. Some British-based banks may decide to leave the U.K. and set up headquarters inside an EU country. Some of the weakness in the financial sector will probably spread to U.S. financials. Preferred securities are vulnerable to a selloff due to the weakness in financials.
   
• We don't believe this will lead to financial crisis similar to the one that followed the Lehman Brothers default in 2008. Banks are well capitalized and central banks are providing ample liquidity. However, it is negative for global growth, which is already very soft. Global trade is growing by less than 3% year over year—that is less than half the historical pace. The leave vote raises impediments to the free flow of goods, services and people, and that is bad for trade. Hence, it could slow the global economy further.

What investors should know

All in all, we're likely to see some volatility ahead. Here are a few things to keep in mind:

• Situations like this are why it's important to hold high-quality bonds as the core of a portfolio. Unexpected events can happen, and high-quality bonds provide the ballast for a portfolio that allows you to ride out the ups and downs of the stock market.
   
• Riskier parts of the bond market, such as high-yield and international bonds, are vulnerable because they are highly correlated with equities. That's why we suggest limiting your exposure to those asset classes.
   
• We remain cautious about non-U.S.-dollar denominated bonds. Investors were facing a diminishing risk/reward outlook for their international bond investments even before the Brexit vote, due to factors including negative-interest-rate policies in various countries. This new shock will not improve the situation.

Next Steps

• Follow Kathy Jones on Twitter: @kathyjones