Funnily enough, market-savvy Brexiteers I spoke to in the aftermath of the vote were surprised but sanguine, saying markets always overreact. Clearly in the short term they were right, with the reaction to Brexit unexpectedly benign. But I do think it’s worth asking whether investors have become too complacent about political uncertainty as a result. Here we are two months on and investors seem more relaxed about political risk than they were pre-vote.
Last month I spoke to Italian Prime Minister Matteo Renzi about the country’s constitutional reform referendum later this year. He has suggested in the past that, if he loses this vote, he will resign and nothing he said to me recently convinced me otherwise. Italy has had 63 governments in 70 years so greater stability is desperately needed, yet voters are pretty evenly split according to the polls.
Why aren’t investors more concerned? Especially when you consider that Italian banks faced huge selling pressure after the Brexit vote amid fears of a need for a larger scale bailout. These things haven’t gone away and the last thing the country needs is political upheaval at this moment.
US presidential election
Italy isn’t the only consideration in the fourth quarter. According to the polls, Donald Trump winning is just as unlikely as a Brexit win was two months ahead of the referendum. Didn’t Brexit teach us not to count our chickens? Yet investors seem totally nonplussed.
Perhaps Trump has scared people enough that he’s thrown his chances away. Perhaps it is the fact that we don’t know what kind of President Trump would make. We can definitely question whether he will really be at daggers drawn with China, whether the Mexican Wall will really be built, and whether Nato really is so unimportant in his eyes. We just don’t know.
On the plus side, either presidential choice will likely bring further fiscal spending and that’s a reason for markets to rejoice.
Monetary and fiscal policy
It would be foolish to assume that the buoyancy in markets is purely fuelled by complacency, particularly when the rally feels so unloved. In fact, the real data so far in the UK seems to suggest that the fears of a collapse in the economy predicted by the surveys were greatly exaggerated – for now at least. The same is true in Europe. And where central banks are concerned, the belief is that lower for longer rates could very easily be lower for just about forever.
Political risk was also washed away by the continued waves of monetary stimulus. There’s more and more talk of fiscal spending support around the world not only from US electoral candidates but also from the UK government, Japan and in Europe.
The only central bank that could reverse the mood this year is the Fed. Janet Yellen acknowledged the improvement in the US economy at Jackson Hole last week and that message was strengthened by vice chair Stanley Fischer. Yet most analysts and investors believe that an interest rate hike will come in December or later. Another reason to hold your nose and buy.
Still reasons to be cautious
So the monetary environment still feels supportive for risk sentiment. I get that. Then add in investors’ apparent ability to shrug off impending doomsday scenarios similar to the Brexit vote and you’ve got a solid recipe for a continued asset price rally.
But at these lofty heights in equity markets and with unknowns like Italy and the US presidential election ahead of us, I’d argue there’s still reasons to be cautious.