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Market Insights: Brexit—Cooler Heads Typically Prevail

As you are likely aware, the U.K. voted on Thursday to leave the European Union, which is sending ripples through global markets. This is symptomatic of the growing anti-establishment movement that is becoming more of a global issue.

The initial global reaction appears very negative (particularly in foreign equities), as this was clearly not expected, and therefore it was not priced into markets. While there may be some near-term investment opportunities from the market reaction that ensues, it’s important to recognize the global economic implications of this, especially at a time when the global economy is already very fragile. This vote will heighten fears that the U.K. will enter a recession and this may very well call into question the future of the European Union as we know it. The U.S. dollar and the Japanese yen are expected to strengthen, which is likely to weigh on corporate earnings and economic growth for both economies. China is also reliant on the health of the European economy, as it has substantial exports to Europe and is already faced with slowing economic growth and deteriorating credit conditions. Ultimately, this will likely weigh on global economic growth, making any increase in U.S. interest rates improbable. As shown in Exhibit 1, Fed Funds Futures are now implying only a 12.6% probability of a hike in interest rates by the end of the year, down from 50% yesterday, with a 8.5% probability of a cut in interest rates.

Exhibit 1: Fed Funds Futures—Implied Interest Rate Probabilities (06/24/16)

Implied Interest Rate Probabilities

Source: Bloomberg

On a positive note, we have seen some support for risk assets this morning in the face of heavy selling overnight. Specifically, Exhibit 2 shows the intraday price of S&P 500 E-mini Futures which demonstrates the support that we have seen for U.S. equities since the overnight lows. Exhibit 3 highlights the yield of the U.S. 10 Year Treasury Bond, which also bottomed at approximately 1.4% overnight and has since made a significant recovery.

Exhibit 2: S&P 500 E-Mini Futures Intraday Price (6/23/2016–6/24/2016)

S&P 500 E-mini Futures Intraday Price

Source: Bloomberg

Exhibit 3: U.S. 10 Year Government Bond Intraday Yield (6/24/2016)

U.S. 10 Year Government Bond Intraday Yield

Source: Bloomberg

To be clear, we don’t expect rates to continue to rise, but this is meant to serve as a sign of very near-term stability in markets. It’s also important for investors to recognize that we may see more selling pressure later today and into next week depending on a variety of factors, including but not limited to how central banks respond to this incident. Although this type of market volatility feels unusual and concerning, we’ve been here before and cooler heads typically prevail when markets react like this.

The Wilshire Funds Management Investment Strategy Committee will assess the outcome of the Brexit vote judiciously and determine how portfolios will need to be adjusted based on the implications to our global economic outlook. In closing, we believe that this heightened market volatility is within expectations and we may continue to see a tumultuous environment in the near-term. We continue to promote diversification to dampen the volatility of our client portfolios with the objective of achieving long-term financial objectives.

Disclosures
Wilshire Funds Management (“WFM”) is a business unit of Wilshire Associates Incorporated (“Wilshire®”). WFM delivers Wilshire Advisor Solutions, which include models designed to provide a broad range of outcome-oriented investment portfolios for advisors to use with their clients.

Wilshire is a registered service mark of Wilshire Associates Incorporated, Santa Monica, California. All other trade names, trademarks, and/or service marks are the property of their respective holders.

This material contains confidential and proprietary information of Wilshire. It may not be disclosed, reproduced, or redistributed, in whole or in part, to any other person or entity without prior written permission from Wilshire Funds Management.

This material is intended for informational purposes only and should not be construed as legal, accounting, tax, investment, or other professional advice. Past performance does not guarantee future returns. This material may include estimates, projections and other “forward-looking statements.” Due to numerous factors, actual events may differ substantially from those presented.

This material represents the current opinion of Wilshire based on sources believed to be reliable. Wilshire assumes no duty to update any such opinions. Wilshire gives no representations or warranties as to the accuracy of such information, and accepts no responsibility or liability (including for indirect, consequential or incidental damages) for any error, omission or inaccuracy in such information and for results obtained from its use. Information and opinions are as of the date indicated, and are subject to change without notice.

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