Unexpectedly Intriguing!
June 23, 2016
Market Chaos! Run!

If we go by media reports, there is a very fine line between ho-hum and major fear in the U.S. stock market as it considers the potential outcome of the United Kingdom's popular referendum today on "Brexit", in which the British people will state their preference to either remain part of the European Union or will declare that they no longer wish to remain part of Europe's dominant economic and monetary union.

Here is a case in point from yesterday's headlines, courtesy of Reuters:

Wall Street flat, all eyes on Brexit vote

From that headline, you would expect that Wall Street isn't very emotional at all on the topic of Brexit. If you looked at how U.S. stock prices traded on that day, you would find that they fell by 3.45 points, or 0.165%, on the day before the U.K.'s historic vote.

If you want to use an adjective to describe that level of change from the previous day's close in the market, flat is a pretty good one to choose.

Now, compare that headline with the following one that Reuters produced just over a week ago:

Wall Street falls as Brexit vote becomes major fear

From that headline, you would reasonably expect there to have been major market carnage on Wall Street that day, wouldn't you?

There certainly was, if your threshold for major market carnage in the U.S. stock market involves the S&P 500 plunging downward by 3.74 points, or by 0.180%, from its previous day's closing value.

Clearly, where the the most mainstream of media is concerned, there is a very fine line between ho-hum flatness and outright fear in the markets. It just happens to fall somewhere within the 0.29 point gap between a market index that falls by 0.165% on a day defined by what might be described as mildly watchful apprehension and one that falls by 0.180% from the previous day on a day filled with "major fear"!

Update 24 June 2016, 9:24 AM EDT:

Are you ready for blood running in the streets panic - at least, if we go by Reuters' measure of fear? Via Barry Ritholtz, here are the pre-market futures following the actual Brexit vote:

Pre-24 June 2016 Market Futures, via Barry Ritholtz - Source: http://ritholtz.com/2016/06/brexit-meltdown/

Barry writes:

We haven’t seen numbers like this since the financial crisis — although to be fair, these numbers bring us in the USA back to where we were on Monday, prior to the rally this past week; Europe seems to be getting punished to a much greater degree.

As a heads up for what's going to happen in today's stock market action, we're about to get a case study on what happens to U.S. stock prices when investors suddenly shift their forward looking focus from one point of time in the future to another. In this case, from the distant future to the much nearer term. This will be evident today as a direct result of the Brexit vote outcome.

Where the U.S. stock market is concerned, nothing has changed with respect to the expectations for the amount of dividends that will be paid out in the future - at least, as yet, and thus, nothing has changed with respect to the alternative trajectories that U.S. stock prices might take, except just how far forward into the futures are looking. If you want to know where stock prices are going to go, figure out how far into the future investors are looking (use the following chart as your guide, in which we've sketched in how the stock price futures for the S&P 500 stand before the market opens.)

Alternative Futures - S&P 500 - 2016Q2 - Standard Model - Snapshot 24 June 2016, pre-open

We've been through this kind of rodeo with our model's performance before, back when China had its meltdown in August 2015. There will also be a wild card speculative element (noise) in today's trading, but the main shift in the trajectory of stock prices should become pretty apparent over the next several trading days, if not sooner.

As for what to expect, assuming no new unexpected events impact the market, should investors remain focused on either the near term future defined by 2016-Q3 or 2016-Q4, the S&P 500 is likely within 1-2% of where it will end the day. It is certainly possible that an outburst of speculative noise might erupt in the market, which could take it down by an additional 4% from where it looks set to open, but the immediate impact of the Brexit event itself will likely fade during the day, leading stock prices to stabilize.

It is also possible that the world's central banks will take an action that will succeed in refocusing the attention of investors on the more distant future, which would be accompanied by a significant rally.

We'll have fun watching how it all plays out!

Update 24 June 2016, 9:38 AM EDT:

Via Eddy Elfenbein's Twitter feed:


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