Brexit and the Investment After Effects

Financial mavens and governments immediately went to work Monday morning on understanding the aftermath of the UK's choice of the Brexit option.
Obviously this is a shock,said Jurrien Timmer,head of Global Macro at Fidelity Investments in Boston.The UK economy needs to adjust;the stock market and banks need to deal with this new reality.It's not surprising the financial sector is taking the brunt of the hit here.Somebody threw a bunch of sand into the gears.It's a period of reassessing where the growth is,how trade pacts and other agreements are going to be rewritten.*
The S&P 500 has been stuck on 1800-2100 for about a year-and-a-half.Now we have a negative catalyst that I think will lead to revaluation of US and world equities.We may see some form of stagflation,which is really more consistent with a 15x multiple.It's pretty orderly;it's just the market needs to rerate based on a new fundamental.Bascally it depends on how systemic a Brexit is.For the US investor,it's somewhat systemic.I think some degree of rerating is in order.We're a somewhat closed economy.The 15x multiple will lead to basically the lower edge of the range,but no farther.*
The Lehman moment was a liquidity crisis,a funding crisis.With central bank policy over-accommodative here,that's not going to be an issue.I don't see it necessarily as a crisis,unless the euro comes under attack,and it's too early to see that.If the Fed moves to the side,that's definitely an offset.I do think we're going to go into fiscal stimulus in the UK.The UK government could basically fund pretty aggressive stimulus.Even without a shock,some US focus on fiscal stimulus is likely in the election season.*
If we're moving into a mild stagflation environment,we could see less growth with more inflation,so some inflation-protected investing would be in order,Mr.Timmer advised.*
Responding to the Brexit vote,S&P lowered the UK's credit rating from AAA to AA with a negative outlook.*
Investors will be looking into Treasury Inflation-Protected Securities,or TIPS,a type of government bond suitable for buffering portfolios in a stagflation environment.The TIPS bonds' principal is indexed to the Consumer Price Index and rises and falls accordingly;while the TIPS bonds' coupon rate remains steady,yielding more when multiplied by the rising CPI in inflationary conditions. *
iShares TIPS Bond ETF (TIP)

Where This Leaves Us

Shane Oliver of ANP Capital Investors in Sydney,Australia thinks we are 85% through the bear market.We are probably near the bottom of share prices.Stocks are very cheap now.Mr.Oliver likes the telecom and consumer staples sectors.Peter Redward of Barclays Capital(BCS) says the Federal Reserve is doing all it can to make sure that Lehman Brothers unwinds its positions systematically.Ultimately,the market has to work as well.Earnings multiples have to come down because of widening credit spreads.At this point,financial markets are leading the economy.Before,it was the other way around.In consequence,the economic dynamics we've had are unlikely to continue.Countries such as South Korea and India are vulnerable because of their current accounts deficits,Mr.Redward feels.Today the Federal Reserve releases its interest rate decision.This could be a market-mover.In any event,shares of McDonalds(MCD) and Johnson and Johnson(JNJ) were up this morning.

Shop Talk

Today I extend a special greeting to Washington,D.C..I advertised there this week.I've been advertising in many foreign countries,so I want to turn to American cities as well.I can't take them for granted just because they're my own.Reporters will be working through the weekend as another investment bank crisis reaches a climax.Lehman Brothers(LEH) is expected to be purchased over the weekend.The story would be in the shape of the deal.Asian markets would register the first reaction to it on Sunday evening.

Jersey Helps Lehman

Lehman Brothers(LEH) is raising six billion dollars U.S. in new capital.Investors include the New Jersey Division of Investment,the state's pension fund.Common and preferred stock offerings will also be made.The capital is for general corporate purposes,Lehman said.The investment bank said it will report a Q2 loss of 2.8 billion dollars in a few weeks.It is Lehman's first loss since being spun off from American Express(AXP) in 1994.Lehman is in the process of deleveraging.Risk positions hvae been redeuced by 30%,commercial mortgages by 20%,and resaidential mortgages by 20% as well.In consequence,Lehman's profit and price to earnings ratio will be lower than they historically have been.

Lehman's Outcome

Lehman Brothers(LEH) is similar to Bear Stearns(BSC),but has a more diversified business.Erin Callan,Chief Financial Officer,said the dealer's outcome for the first quarter was pretty good.Lehman's earnings were better than expected.The Fed's discount window is a great opportunity for them.The equities markets remain weak.We have a lot of confidence to build back into the system.She wouldn't expect it to feel stable until 2009.There's been a sea change.The question of Lehman's liquidity is now off the table.The much bigger question is what's the best way to run this business model.She was shocked by the Bear Stearns takeout.It was a very bold move by the Federal Reserve,and exactly what was needed to stabilize the environment.It has been very difficult to access unsecured funding for the past three months.For the rest of the year,there will be very little access to it ,if any.Liquidity is only one part of the story.The balance sheet is also important.Ms.Callan expects volatility through the second quarter.Lehman Brothers has been upgraded to a buy rating by Goldman Sachs(GS).

Lehman Goes To Window

Lehman Brothers(LEH),one of the 20 Primary Dealers,has gone to the Federal Reserve's discount window for these firms,or Primary Dealer Credit Facility.At this window,the Fed is taking a broad range of collateral in exchange for cash.Assets accepted include mortgage-backed securities,municipal and corporate bonds,as well as collateralized debt obligations.The assets must be rated investment grade by at least two credit rating agencies and have market prices.The dealers get 95.00 U.S. for every 100.00 of collateral they submit.The transaction goes through a clearing bank such as Bank of New York Mellon(BK),where the collateral is deposited and the cash handed over.The Federal Reserve opened the window to dealers in order to prevent further cash flow problems.On 16 March,Bear Stearns(BSC) was on the brink of bankruptcy when it lost the confidence of partners and clients.Now the dealers can shore up their finances as needed,so long as they have the collateral to put up for the loans.