What I mean is that sterling's fall is due in part to fears that a hard or disorderly Brexit will depress GDP: weaker growth should weaken the pound by reducing future interest rates or demand for money.
If we had a proper market economy, we could gauge this by looking at the prices of GDP-linked bonds, which would tell us market expectations for future GDP. Sadly, in the absence of such an economy we can't be sure that sterling's falls are linked to fears for future output. But we can get an idea from gilt yields. Both real and nominal yields are lower now than they were in May. This tells us that sterling's fall has been accompanied by a markdown in the expected path of short-term interest rates (gilt yields should be equal to expected short-term rates over the maturity of the gilt), which is consistent with a lower path for GDP.
Which brings me to the puzzle. Lower future output should mean lower future dividends and hence lower share prices. So why has the market risen?
The trivial answer is that most earnings of FTSE 100 companies come from overseas and the weaker pound raises the sterling value of these. This is true, but it doesn't explain why even domestically-oriented stocks have also risen.
There are (at least) four different reasons for this, with different implications for investors.
One is that the stock market doesn't believe that Brexit will hurt the economy. This, however, poses the question: why do equity markets think differently from FX and gilt markets? And why are they right and the others wrong?
A second possibility is that a rising tide lifts all boats. Shares are substitutes for each other, so when overseas earners or global markets rise, so too do even domestic stocks. This implies that domestic stocks will continue to do well only if the world economic environment remains friendly. If the 'Trump rally' goes into reverse, they will fall back.
A third possibility is that investors are being too short termist. The harm from a bad Brexit (assuming it comes at all) will come mostly in 10 or 20 years' time as tougher trade and immigration restrictions depress exports and eventually productivity. It's possible, however, that markets simply don't look so far ahead. If profit expectations are anchored by guidance from company management or analysts they might not reflect the longer-term damage of Brexit. Evidence for this is the fact that there's a strong contemporaneous correlation between changes in import prices and price changes for some sectors such as retailers, which implies that the bad news of higher import costs isn't always immediately factored into share prices. And if this news isn't immediately discounted, why should bad news about the longer term be?
What's more, investors might not yet even be factoring in the possible near-term bad news that real wage resistance will squeeze domestic profit margins, or that slower aggregate growth will skew the distribution of corporate growth, causing a disproportionate rise in the number of profit warnings.
All this suggests that domestic stocks are overpriced: they are not yet factoring in the near-term bad news of a possible profit squeeze nor the more distant bad news of slower growth.
But there's a fourth possibility. If Brexit does damage the economy in 10 or 20 years' time, that harm won't fall merely upon companies that are quoted on the stock market today. Instead, unquoted companies and even those that don't yet exist will suffer. In fact, lower long-term growth means that some companies that would otherwise exist will never be born.
A lot of economic growth usually comes not from incumbents expanding but from new companies entering the market. Slower aggregate growth means fewer new entrants, not just worse prospects for incumbents. It's possible, therefore, that domestic stocks might not be overpriced.
For what it's worth, my fear is that investors are underweighting the third possibility, that domestic stocks are underweighting the near-term threat of a profit squeeze. But that's not my main point. The point is that there are some big questions here: will Brexit really hurt growth? Are stock markets efficient? Are investors short-termist? What's the link between aggregate economic growth and the growth of individual companies? How much growth comes from new entrants rather than listed companies? The problem is that the 'debate' about Brexit has become tribal and debased, and this deflects attention from these important questions.
