Brexit aftermath: Where do markets go from here?

Where do we go from here? The markets were positioned for a remain vote and we are dealing with that fallout. We have dodged the immediate bullet: Today's U.S. open, while down notably, was orderly and devoid of the massive trading halts we saw on the last big down day (Aug. 24).

Here are some quick thoughts:

1. On where we are now. We're back where we have been for ages — a little above or below 2,050. Since mid-April, the S&P has gone from roughly 2,100 to 2,030 (mid-May) to a little over 2,100 (early June) back to 2,050, then back to 2,100, and now we're back just a bit below 2,050. In fact, we have hovered around 2,050 for over a year. We could of course go lower, but we are still a ways from 1,800, which we saw in February.
2. On why today's trading may not be a good indicator for the future. This is the Russell rebalancing, the once-a-year rebalancing of the , traditionally the heaviest volume day of the year. There will be very big trades around the close. It's not clear how the heavy volume around the Brexit vote will interact with the large buy and sell orders at the close.
3. On sentiment. It's already depressed and it will be further depressed. Once the first few days of trading are over, this may again prove to be a help to the markets.
4. On what it means for the U.S. Even if Europe's economy slips further, or even into a recession, it's not clear the U.S. won't be able to continue to grow. The problem is, global markets have become more interconnected, not less interconnected. Jury is still out on this.
5. On stocks.
   - Telecom, Utilities, and REITs: will outperform on the prospects of lower rates.
   - Banks: with the safe-haven flight to Treasuries and lower bond yields, bank stocks will again remain out of favor.
   - Defensive sectors: The obvious trade is that other defensive sectors (Health Care, Consumer Staples) will also outperform in the short term. But the knee-jerk reaction will be complicated by the large exposure some Consumer Staples have to Europe.
   - Energy & Materials: Since global commodities are priced in dollars, the currency effect (dollar strength) will be an issue for Energy and Materials stocks.
6. On earnings. Bulls had been arguing that the earnings recession (four consecutive quarters of negative earnings growth for the S&P 500) would be ending in the second half of the year. Q2 earnings were expected to decline modestly, and revenues were expected to be flat. Q3 earnings were expected to be positive as oil companies might begin reporting incrementally better numbers with oil at $50 or above.
   - That scenario is now questionable. Energy and Materials may take a hit on lower commodity prices. Export-oriented Industrials like GE, 3M and Honeywell may encounter significant headwinds with a stronger dollar, and those that sell significantly into Europe may as well.
7. On valuations. Multiples typically expand when profitability improves and contract when profitability wanes. Bulls have argued that markets are fully valued but not overvalued. At current estimates of roughly $117 in earnings for 2016, the S&P was trading yesterday at an 18.0 multiple, on the high side of historical averages but not in bubble territory.
   - That is now down to a more-reasonable multiple of 17.5 or so. Bears will argue that earnings will likely take a hit on Brexit. They also argue that we are at the natural tail end of the economic cycle.
8. On central banks? Bulls insist the Fed will remain accommodative, with a good chance of no interest rates for the rest of the year. The Bank of Japan will continue to buy equities and may even increase their purchases. The ECB may even begin to buy stocks.
   - The bear argument will not change. Central banks around the world are slowly losing their credibility. Negative interest rates and rates persistently near zero are bad for psychology, bad for savers, bad for the financial industry, and forces investors and savers to reach for yields in ever-more risky segments of the market.
9. On oil. The issue is whether oil will stabilize near $50. The hope is that the worries dominating the collapse of oil that were dominant in the first half of the year will greatly subside in the second half: the collapse in Energy earnings and capital spending, job losses and worries over credit defaults and the impact on banks.
   - Bears will insist low oil is here to stay. Technology makes it easy to ramp up shale production. New production is coming online from Iran. Solar and even wind are becoming more viable competitors as costs decline and the efficiency of the technology improves. Every oil producing country in the world knows this and is producing as much oil as they can right now.
10. On China. Much of the problems the markets saw in February were due to China. But Chinese authorities have stabilized the stock market and the renminbi.
    - This has stabilized China's markets but not improved foreign investor confidence in Chinese authorities. Chinese authorities have convincingly demonstrated that they are clumsy and heavy-handed when dealing with markets and show an authoritarian streak and a hostility to free markets. Just ask MSCI: they turned down the inclusion of China mainland shares in their indices because fund managers were not convinced they would be able to get their money out in the event of another rout.
11. On the U.S. election. The bull narrative has been that appears to have a modest lead. Bulls argue that the markets can live with a Clinton victory, provided it is combined with a Republican Congress (at least a Republican House).
    - But many have noted the Brexit may give a boost to Trump, or at the very least highlight the widespread discontent. Others note that Clinton could blow up over her email issues and that Trump could mount a coherent and effective campaign. And the conventions could blow up any narrative.

The bottom line: The Brexit has the potential to change the narrative on the biggest issues that matter to markets.