Investors this week face a barrage of European economic and political events that should leave them rattled. But on Monday, as they were allegedly staring into the great unknown, they were as complacent as cattle grazing on a mountain pasture. How to explain that?
Their reaction seemed so counterintuitive. The week started with the news that Nicola Sturgeon, Scotland's First Minister, will seek a second Scottish independence vote some time between the autumn of 2018 and the spring of 2019. As early as Tuesday, though more likely at the end of the month, Britain will trigger Article 50 of the European treaty, signalling the start of formal negotiations for Britain's exit from the European Union – Brexit. Never mind that "Britain" might not even exist then, if Scotland bolts before the two-year Brexit process is finished.
The barrage of uncertainty continues on Wednesday, with the Dutch election, the year's first test of the apparent populist, euroskeptic surge that threatens to squeeze the life out of the EU's mainstream centrist parties and their pro-liberal economic order.
Yet investors yawned. In London trading, the pound rose 0.5 per cent, to $1.22 (U.S.), and the benchmark FTSE-100 index climbed 0.4 per cent, putting it near its record high. The index has climbed 20 per cent in the past year. The FTSE-250 index of mid-sized companies closed at a record high. The yield on 10-year British bonds barely moved. The top stock indexes in the euro zone also rose. In both Britain and the euro zone countries, economic growth is fairly strong.
Investors were not stunned. They were doing what they usually do, which was to take the view that all the potentially disruptive news was now priced in so why get ahead of the pack and buy? And buy they did.
Their view makes perfect sense today. It may make perfect sense in a month or six, even a year. But the Brexit process, which has yet to even start, and a new Scottish referendum (assuming it receives parliamentary approval) are bound to damage both the British and EU economies at some point, though far more the former than the latter. When it sinks in that Brexit is a no-win situation, investors will surely take a negative view of Britain.
At the moment, Britain is a fine place in which to invest for the simple reason that prices, thanks to last June's pro-Brexit referendum, are a lot cheaper than they used to be. The pound has lost about 15 per cent in the last year (a London friend of mine, who runs a small financial business, says that, for the first time in memory, he can hire lawyers and programmers at less than New York prices). FTSE-100 countries derive most of their sales outside of Britain and are using the cheap pound to haul in the profits.
While some economists think investors have failed to factor in the risks of Article 50, others argue its that it's something of a non-event, since everyone knew that it was coming. "There may be many Article 50-related news headlines in the coming weeks but we believe that a lot of the negativity around Brexit-related economic data weakness is already in place," Morgan Stanley strategists, led by Hans Redeker, said in a recent note.
But what about the risks of the Scottish referendum? Or the Dutch election and French elections, which could swing in the favour of the populist, anti-EU parties.
Again, European investors don't seem overly concerned, at least not now. In market terms, the Scottish referendum is a long way away and an exit result far from assured. In the independence referendum in 2014, the pro-Britain side took 55 per cent of the vote, with the pro-independence side taking 45 per cent. A spread that large – 10 percentage points – is close to landslide.
Scotland trades more with Britain than it does with the EU. Scotland is also in a weaker economic position than it was three years ago because of the collapse in oil prices, which sent Scottish oil revenues from the North Sea spiralling downward. Scotland's economic status is potentially dire. At last count, its budget deficit was running at almost 10 per cent of gross domestic product, well more than twice Britain's level.
In reality, Scotland needs Britain, financially and economically speaking, a lot more than Britain needs Scotland. Investors are not being cavalier in assuming that the risk Scottish independence is low, because it is low.
Ditto victory by Geert Wilders, leader of the far-right, xenophobic Freedom Party in the Netherlands. There are 28 parties in Wednesday's Dutch vote and Mr. Wilders is unlikely to be able to form a government even if his party wins the most votes, which is also highly unlikely. In France, the polls say that Marine Le Pen of the EU- and euro-hating Front National is likely to win the first round in the presidential poll in April, but not the second.
Investors, of course, could turn from bullish to bearish in an instant if they realize they have underestimated the political and economic risks of Brexit, or if the polls put the Scottish independence movement in the lead. In the meantime, they remain unfazed and the cheap pound is working as a perfect shock absorber. Monday's market reaction was not illogical.