This poses the questions: does this show that equities are prone to overreact? And: does it mean that economists were wrong to warn that Brexit would hurt the economy?
There's a puzzle here. Early indicators suggest that economists' warnings were right. Surveys by Deloitte, the CBI and Institute of Directors show that investment intentions have fallen; GfK reports the biggest drop in consumer confidence since 1990; and Markit's survey of purchasing managers shows that manufacturing activity has fallen despite the weaker pound boosting exports. All this suggests that economists were right to say that the uncertainty caused by a vote to leave would have an immediate depressing effect upon economic activity.
This makes it all the odder that the 250 should have recovered. So why did it? There are three reasons.
One is that global stock markets have risen, and this has dragged up mid-caps. Since its low point on June 27, the S&P 500 has risen by 8.7 per cent. Post-1985 relationships suggest this alone should have raised the FTSE 250 by 7.4 per cent; even the most domestic of UK stocks benefit from rising global equities.
There is, however, a complication here. The rise in the S&P 500 isn't wholly exogenous. Instead, one reason for it has been that fears have faded that Brexit would prove bad for the global economy. This is consistent with markets overreacting to the vote.
A second reason for the rise in the 250 has been that macroeconomic policy will be more supportive of share prices than investors expected it to be before the referendum. As I write, the Bank of England is considering loosening monetary policy. Although this is unlikely to give a great boost to economic activity, it could help shares: experimental evidence from Harvard Business School shows that low interest rates raise demand for equities even if they don't raise profit expectations.
We might also see fiscal policy support shares. New prime minister Theresa May has said she will no longer aim at a budget surplus by 2020. Looser fiscal policy should mean higher future GDP and hence higher corporate earnings, which should benefit equities now.
You might object that, with strict inflation targeting, any fiscal stimulus should be offset by tighter monetary policy, leaving equities no better off. But this isn't what markets expect. They are now pricing in a three-month interbank rate of 0.5 per cent for December 2019, compared with an expectation of 1.2 per cent on 23 June.
There's something else: Brexit might not happen. Sky Bet is offering odds of 7/4 against Article 50 being invoked after 2018 or not at all, implying a possibility that we'll never leave. Yes, this is only a possibility. But share prices reflect the probability distribution of future possibilities, not just the central case expectation. A small but increasing chance of us staying in the EU would justify a rise in the 250.
One inference of all this is that supporters of Brexit should not infer from the return of the 250 to its pre-referendum levels that Brexit won't do economic damage. This is because there might well be other reasons for the 250's recovery.
But there's a broader point. We can't say for sure whether share prices tend to overreact or not, simply because the real world is too messy to give us clean evidence. In this sense, the old debate about whether shares are irrationally excessively volatile might never be settled for sure.
