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Brexit Market Shock Has Waned, but Don’t Relax Yet

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While Raymond James Chief Investment Strategist Jeffrey Saut offered some prescient advice Monday by telling investors – and the media – to “sit back and take a deep breath” on news that the UK voted to exit the European Union, other market pundits are bracing for a potentially bigger market shock as France makes noises about leaving the bloc.

Predicting slower growth in the months ahead, Bank of England governor Mark Carney hinted Thursday that the central bank would need to cut its key interest rate “over the summer.”

For now, markets have bounced back since the U.K.’s June 23 Brexit vote, with the stock market rallying Wednesday and Thursday while the pound dropped.

“I think it was futile to instantly speculate on the ensuing economic damage,” Saut wrote in his Monday commentary. “My advice to the media last Friday was to do nothing. Better to take a breath, sit back, and analyze the facts over the weekend. Above all, I stated, do not panic. Maybe it’s because I am old, or the fact that I have seen this type of action before, but this kind of news generally only has a short-term impact on the markets.”

Jeffrey Kleintop, chief investment strategist for Charles Schwab, opined Monday, however, that volatility will remain a “major characteristic of markets in 2016,” noting that short-term-focused traders should be prepared for further stock market declines over the next three to six months.

Investors with longer time horizons, however, “may want to maintain their diversified asset allocations, which can help portfolios weather volatility over time,” Kleintop advised,

Kleintop also warned of a bigger fallout from potential Frexit, as French “far-right leader Marine Le Pen hailed the Brexit vote and immediately called for a similar referendum in France,” Kleintop notes. A “Frexit,” he says, “could be even bigger than Brexit in its impact on markets, with a European Central Bank that may be unable to effectively intervene.”

Other countries calling for their own referendums on European Union membership, Kleintop says, “could put the European Central Bank in a difficult position to continue its quantitative-easing program of buying the bonds of countries that may choose to leave the eurozone.”

Europe, meanwhile, “could fall back into recession as fear of a [EU] breakup begins to affect capital investment, hiring and consumption,” he says.

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Indeed, Greg Valliere, chief investment strategist for Horizon Investments, sees “two major risks” going forward: First, that France schedules a vote to opt out of the EU, which would be the ultimate train wreck scenario; Second, that global economic growth slumps largely because of a pervasive drop in confidence — businesses are curbing investment because of uncertainty, and consumer confidence is likely to slump further in light of stock market volatility that may persist for some time.

Mike Amey, a managing director and portfolio manager in PIMCO’s London office, sees the market reaction to Brexit as, for now, “more a local rather than globally systemic event.”

So far, he writes: “The largest moves have been in UK related assets: the British pound, UK gilts and UK bank stocks. US treasuries have also rallied, benefiting from a flight to quality. If this pattern holds, it is consistent with the tightening in financial conditions being most pronounced in the UK with a much less extreme tightening at the global level.”

How markets move “over the next days and weeks will give us more clarity on this, with market moves outside of UK assets key.”

Anthony Valeri, fixed income and investment strategist for LPL Financial, sees high-quality bonds as winners post Brexit.

“Flight-to-safety buying, which is typical in response to market or geopolitical shocks, propelled Treasuries to strong gains” in response to Brexit, he said Wednesday.

“Investor response wasn’t all about the economic uncertainty, however. Brexit results are likely to influence central bank policy, a key driver of bond prices and yields. Negative potential economic implications and the likelihood for more market-friendly central bank policy from the Bank of England and Federal Reserve, the two major central banks that were the most likely to raise interest rates, may continue to reinforce the lower for longer theme in the bond market.”

— Check out After Brexit Vote, Is ‘Stay the Course’ Really the Best Advice? on ThinkAdvisor.