Sometimes what does not happen tells us as much as what does happen. This is true of the stock market’s reaction to uncertainty about Brexit.
Last Thursday, Dominic Raab’s resignation in protest at the withdrawal agreement negotiated by Theresa May (and himself) raised the prospect that parliament would reject the agreement, leading to us leaving without a deal, or that there’d be a challenge (apparently since faced down) to Ms May’s leadership or even a general election. The FTSE 100’s response to all this fevered speculation was to rise five points. Yes, smaller shares fell, dragging the All-Share index down. But it only dropped 0.1 per cent, about as much as the S&P 500.
Granted, the FTSE 100 has lost 8 per cent since the Chequers plan was published in July. But very little of this fall can be blamed on Brexit. One simple fact tells us this – that other markets have fallen as much as the UK. If we exclude the US, MSCI’s world index has also lost 8 per cent since then.
Political turmoil has not caused market turmoil. There are good reasons for this.
One is that equities have some shock absorbers helping to protect them from such uncertainty.
Not least of these is sterling. It has tended to fall whenever the prospect of a no-deal Brexit has risen. Such a fall is not helpful for the domestic economy: in raising inflation it cuts real incomes thus offsetting the weak boost to net exports. It is, however, good news for the many stocks whose earnings come from overseas. It’s no accident therefore that mining and oil stocks did especially well on Thursday, and that big stocks (most of whom are big overseas earners) outperformed smaller ones.
We mustn’t, though, overstate how jittery sterling is. Since the publication of the Chequers plan its daily volatility has been only slightly above its post-1993 average. We saw much greater volatility during the financial crisis as well as in 2000 and 2004. Political pundits’ talk of Brexit disturbing the markets contains a large chunk of hyperventilating lack of perspective.
There’s a reason for this lack of volatility. It’s that there’s upside risk for sterling as well as downside risk. The possible collapse of the withdrawal agreement raises the chance not only of a no-deal Brexit, which would cause sterling to fall, but also of us remaining in the EU. As the prime minister said, the options are her deal or to “leave with no deal or no Brexit at all”. The latter would see sterling rise, although maybe not back to the $1.45 it was before the 2016 referendum. You might think this an unlikely prospect, but asset prices are set not just by the most likely outcome but by the range of probabilities.
A further support for shares is simply that markets are globalised. Not only do FTSE 100 companies get most of their earnings from overseas, but also UK shares are near-substitutes for overseas ones, which means that the UK market should rise and fall as the global market does. If the latter rise, therefore, UK stocks would get a lift even if the domestic political background is unhelpful,
Yet another cushion for shares is at the Bank of England. Barclays’ Fabrice Montagne says that in the event of a no-deal Brexit the Bank of England would cut interest rates to support the economy; this is a big reason why sterling fell on Thursday. That would help shares – especially perhaps the overseas earners that would benefit from lower rates without being hurt much by weaker UK economic activity.
A no-deal Brexit is, however, not the only political risk. The chance has increased of an early general election that Labour wins. It was the utilities sector that fell most on Thursday, reflecting the fact that these would be most hard-hit by a Labour government intent on nationalising them on perhaps unfavourable terms. It’s also likely that Labour’s plans for higher corporate taxes would hurt shares generally, at least temporarily.
Again, though, there’s a silver lining here. A Labour government would mean a very soft Brexit or perhaps even no Brexit at all, if it holds another referendum. That would boost sterling and domestically-oriented stocks.
Underlying all this is another question: how much does policy actually matter for economic growth (which is what, ultimately, determines share prices)? True, it’s widely agreed that Brexit would depress trend growth – although this much should by now be largely discounted except insofar as there remains the hope of us reversing that choice. But on the other hand economists such as John Landon-Lane and Dietz Vollrath have shown that longer-term growth is largely unaffected by most domestic policies. It is instead driven by emergent and often global forces over which policy-makers have little control, and sometimes (initially at least) little awareness.
For years, this view has been regarded as pessimistic, implying that policy can do little good. But the converse is also true to some extent – that, within reason, policy can do little lasting harm. Yes, bad policy choices are likely – and a no-deal Brexit would be one of these. But bad policies tend to be reversed. Perhaps, therefore, we overestimate the influence of politicians upon the economy for both good and ill. The stock market’s apparent indifference to Westminster’s shenanigans is consistent with this.
