UK economy seems well shielded by the effects of Brexit from an intermarket standpoint!

Technical Analysis of the Economy from a fundamentalist standpoint!

Intermarket Technical analysis of the four market groups, bonds, stocks, commodities and currencies paint a meaningful, yet not a dire, picture of the economic health of Great Britain, which already has been hard hit by Brexit.  Taking FTSE 100 as the proxy of the stock market, it has been witnessed that the stock market has not been so badly hit as one would have expected.  As can be seen from Figure 1, that FTSE has been relatively bullish as of late.  Sterling Analysis from an intermarket perspectiveBut this should not be construed as sign of UK’s economy robustness.  What is worrisome is to note that the relative strength of FTSE 100 with that of the Sterling Index gives a view of a slightly inflated stock market, which can make it more prone to a sudden drop.  Also an inverse proportionality has been maintained between the sterling index and that of Brent crude oil which would serve here as a proxy of commodity market.  The normal market relationship is that bonds and stocks normally trend in the same direction, with bond acting as a leading indicator of for stock market turnaround.  Bonds also tend to trend oppositely to commodity market.  Looking at figure 2 we can see that short term bond yields on 2 year UK treasury bonds have been on a steady positive decline, which shows that bonds market has been performing quite well over the last few years and that there is not much to suggest that they may start under-performing in the near term future.  However, the graphs also show that the long term yields have declined and are approaching the short term yields, suggesting the declining confidence of investors about the short term state of the economy.  Reviewing points D1, D2 and D3 we see that only when the long term yields undershot the short term yields the term structure reversed.  This happened during 2001 and right before the 2008 recession in 2007, in all cases there was a reversal of term structure and economic slowdown ensued.  Looking at Figure 2, we witness the long term yields approaching the short term, but still a healthy distance away, which gives us room to believe that the economy has enough buffers to keep on performing well.  Also the term structure for now does not show any sign of developing a negative slope which could paint a derelict picture of the economy.

2 and 5 year treasury bond -resized


Plateauing Term Structure copy

We also see that, with Brent acting as a proxy of commodities market, sterling has mostly held a negative correlation with crude oil movement and currently there is no reason to be highly bullish on this commodity type, as its price action is only in a corrective state.  Accordingly, high levels of appreciation cannot be expected.  It is only, when the price cycle is in its bullish run, that sterling index can start to falter when commodities go into a boom.  The secular trend shows that this phenomenon is still some distance away, and that the normal inter-market relationship would have to hold, which is for stock market to follow the bond markets on the decline and with sterling collapsing and commodities booming.  The current relationships don’t point to such an inter-market scenario, thus, there appears less reason to worry, even in the case of Brexit!!!



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