Brexit Means Much Less Joy for Global Investors

The 1983 film The Big Chill chronicles changes that a group of friends in their 30s had gone through since their college years at the University of Michigan in the 1960s, the last decade of any importance and interest. (Appropriately enough, I was 34 when the movie premiered.)

The film centers around the group gathering following their friend Alex's suicide. A charismatic science prodigy who became a social worker and then a manual laborer, Alex was a victim of terminal depression. During their reunion, his friends must probe for their own symptoms of the disease:

Sam Weber (played by Tom Berenger) enters a room where Nick Carleton (William Hurt) is up late watching TV and says: What's this?

Nick: I'm not sure.

Sam Weber: What's it about?

Nick: I don't know.

Sam: Who's that?

Nick: I think the guy in the hat did something terrible.

Sam: Like what?

Nick: You're so analytical! Sometimes you just have to let art ... flow ... over you.

-- The Big Chill

The friends spend the weekend confronting the personal truths, sacrifices and betrayals that have left them disenchanted with their lives. Each also has to contend with unresolved issues they have with Alex and with one another.

To me, the movie could serve as a metaphor for last week's Brexit vote. British voters' decision to abandon the European Union followed decades of cohesion in Europe and a broader trend of globalization that flourished in the 1990s and early 2000s (and led to a boom in global trade).

Born out of the ashes of World War II, the EU had been a pillar of global order -- just as the 1960s had been an important experience for The Big Chill's characters. But just as Alex's suicide forced the film's characters to confront a violent change, so to is the world order that the EU represents suddenly facing a major upheaval.

Not Business as Usual

"I think a lot of the market reaction is less about the financial impact and more about populism and what it means for the liberal economic order. ... The Brexit vote reflects a deep distrust of the benefits of the global economic system among a wide swath of voters in Europe and the United States, and a broadly held view that government institutions -- whether in Washington or Brussels -- are calcifying and don't work well. ... Both of these forces have a lot of wind at their back."

-- Glenn Hubbard, Columbia Business School dean

Dr. Jeremy Siegel told CNBC's Squawk Box yesterday morning that the Brexit will have only limited adverse effects. I disagree.

Rather, I believe that Friday's vote will likely lead to the EU unraveling and a dampening of global economic and profit growth. In fact, I think the Brexit will be far more corrosive than what we saw from the Greek crisis and other economic, political and geopolitical issues that have emerged in recent years.

The Federal Reserve and the U.S. Treasury bailed out the banks that created the U.S. housing and credit bubbles, but populists and insurgent politicians will no longer roll over for that. People are no longer willing to rely as heavily on unelected officials and institutions. The strong arm of populism is taking back countries, governments and even central banks that many voters disagree with.

Perhaps that's why Friday's global market meltdown was the largest one-day drop in years (and possibly ever). Markets obliterated more than $2 trillion of asset values, and Britain moved from the world's fifth-largest economy to No. 6 in a single day.

As I've often written: "In a paperless and cloudy world, are investors and citizens as safe as the markets assume we are?"

It should now be apparent that the answer to that question is a resounding "no" -- and that investors around the world are likely in the process of resetting financial-asset values lower. As Yogi Berra once put it: "The future is not what it used to be."

As I wrote earlier, the Brexit vote's rejection of the 1990s/early 2000s globalization trend reminds me of the 1983 film The Big Chill's look at how the world changed between the 1960s and the 1980s.

Let's check out some things that I foresee happening as a result of last week's vote:

A Wounded (or Dying) European Union

Like most divorces, the Brexit could take longer than most expect. This could prove to be even more disruptive to growth as uncertainties expand and business decisions remain frozen.

The European Union will also probably unravel as other EU countries likely hold their own exit votes. A Grexit, Ital-exit, Frexit and more could follow Friday's Brexit vote, and even the United Kingdom itself could break up as pro-EU Scottish nationalists push for independence.

European Banks Tank

European banks are now more exposed than ever due to poor management, leverage, losses, derivatives and opaque reporting. The prospect of "lower-for-longer" interest rates will also threaten already punk bank profits. As a result, credit-default swaps are quickly widening.

In Is Deutsche Bank the Canary in the Coal Mine?, I ran down the European banking system's potential "contagion" of systemic and counterparty risks. This exposure isn't economically friendly to either the world or Europe (which relies more heavily on bank financing than the U.S. economy does).

Rather, the Brexit only boosts the region's banking risks. In the extreme, this could lead to capital outflows and bank runs that would devastate European countries' banks and economies -- and possibly serve as a broader contagion.

Slowing Global Growth

The Brexit and its implications represent a big shock to aggregate global demand, as the EU has a slightly larger gross domestic product than America has.

Sell-side analysts say the EU's annual economic-growth rate could lose one to 1.5 percentage points due to the Brexit, while Britain could give up as much as three percentage points in annual growth. U.S. companies like Caterpillar (CAT), Ford (F) andHewlett Packard (HPE) that have large a U.K. presence will likely suffer at a time when they already face pressures here at home.

A Flight to Safety That Could Hurt America

The 10-year U.S. Treasury yield has fallen to about 1.46%, down about another 10 basis points from Friday. The U.S. dollar is also strengthening.

Unfortunately, a continued "flight to safety" that strengthens the greenback will represent a tightening financial condition for our country, which could slow domestic growth.

Clinton vs. Trump

Many believe that the Brexit vote and its associated nationalistic trends will benefit Republican presidential candidate Donald Trump, but I disagree. I think the Brexit could harm a Republican candidate that many perceive as ill-equipped to deal with such profound global uncertainties and change.

Polls conducted over the weekend show Democrat Hillary Clinton's lead over Trumpexpanding, and the Brexit makes my "16th Surprise for 2016" -- a Trump withdrawal from the race -- more likely, not less.

The Brexit and the ECB

The European Central Bank's fragile consensus -- upon which the most questionable monetary policy resides -- looks like it's in jeopardy in the Brexit's wake.

The ECB's massive bond-buying campaign has led to a broad decline in European bond yields, and even to negative interest rates in some cases. But this program could face market reality in the wake of the Brexit, with the ECB ever more weakened and bank chief Mario Draghi's policies further questioned.

Don't think for a moment that such ludicrously low yields are invulnerable to a large market reset. If that happens, European banks with heavy sovereign-bond holdings will reel from even more losses.

In other words, the EU bond-carry trade (bonds bought on repo) might be dead.

The Brexit and Interest Rates

As I previously noted, 10-year Treasury yields has dropped about another 10 basis pointsthis morning.

In essence, the Brexit is basically serving as another bout of monetary easing. Treasury yields are dropping like a stone, and I believe that the Federal Reserve is done with any rate hikes for the rest of 2016.

This will further disadvantage savers, who will hoard cash and reduce personal expenditures in what's called the "paradox of thrift." Pension plans and insurance companies like MetLife (MET) and Lincoln National (LNC) will also suffer badly from low-return investments. And with the time value of money at essentially zero, capital expenditures that were already challenged will suffer even more over 2016's balance and into 2017.

Correlations Move to 1.0

I expect carry trades to be unwound and margin calls to escalate under the conditions noted above.

The Bottom Line

There was no real tension in the markets prior to the Brexit vote results coming in on Thursday evening, but that's all changed now.

The above factors all point to heightened uncertainty and less-friendly market valuations. As a result, my baseline expectation -- that U.S. stocks began to make an important, broadening market top in May 2015 -- seems ever more likely. However, the Brexit vote probably means that far more volatility will likely accompany this topping process.

Many players have become accustomed to stocks staging V-shaped bounces over the past few years, but I don't expect that following the Brexit vote. Instead, I think this is a time to be risk-averse and maintain larger-than-normal cash reserves.

Err on the side of conservatism, as I believe that the Brexit and its aftermath will exert a negative, far more profound influence on the markets than prior events have over the past five years.

"Nobody said it was going to be fun. At least, nobody said it to me."

-- Richard Bowens (played by Don Galloway), The Big Chill

One big difference between The Big Chill and the Brexit is that the movie ends with the Three Dog Night song Joy to the World as the credits roll.

Unfortunately, I think the Brexit means that there'll be a lot less joy to the world for investors and traders over the next few years.