What really scares markets about the latest Brexit mess

Theresa May’s postponement of the Brexit vote has increased the chances of no deal. That’s rattled the markets. But it wouldn’t be the worst outcome. John Stepek outlines the markets’ biggest fear.

Jeremy Corbyn: the markets' worst nightmare

Yesterday, the big vote on Brexit that was meant to happen today, was cancelled.

Long story short, Theresa May knew she couldn't win. So she preempted rejection by yanking the vote and declaring she would head back to Brussels to get more reassurances on the whole question of the backstop.

And even although it was pretty clear by now that the prime minister had no chance of getting her deal through on the first round, markets didn't like it.

So what happens now?

A national humiliation? Or an exhilarating democratic workout?

Theresa May spent most of yesterday being told off by various MPs for pulling a vote that she couldn't win.

Lots of them used their time to call for a second referendum. Lots of them just wanted her to go.

From a political point of view, it's messy. You can gaze aghast at this and clap your hands over your eyes and consider it a national humiliation, or you can accept that our democracy is getting a good workout after a couple of decades spent moaning about how all of our politicians were the same.

This is Hyman Minsky in the political realm rather than the economic. Stability breeds complacency, which breeds instability. Our politicians and, I suppose, our "elites" (although that does feel like the wrong word establishment is probably better) took a lot of things for granted.

As a result, a lot of dissenting voices were ignored, a lot of problems were swept under the carpet (the most obvious economic one, for example, is rampant wealth inequality exemplified by soaring global house prices), and now we're seeing the fallout from that.

Take a step back. The UK is hardly alone in experiencing political upheaval. So far, Britain has dealt with it by having referendums (the Scottish referendum is part of all this, too). France is dealing with it by rioting. The US is dealing with it by electing Donald Trump.

The global order is being reshaped, and that's a messy process. In the past we've done it with war and revolution. Hopefully we can avoid that this time. If we do, you have to consider that a result.

And in case you're wondering yes, this is my way of telling you to look on the bright side.

Anyway, let's put all that aside for the moment, and talk about how it all affects markets.

Investors did not react well to yesterday's pulling of the vote. The pound tanked and the FTSE 100 and FTSE 250 didn't do terribly well either. Why is that?

Well, on the stockmarket front, it is worth understanding that global markets did badly in general yesterday. That's because the US did that thing it often does of having a panicky plunge in the first half of the session, which scared everyone in Europe and saw markets close at their lows. Then the US gets its act together, calms down, rallies, and closes on a high note. But of course, by then, European markets are shut.

So that's the backdrop.

But it's definitely not just about the global slide. The thing that most disturbed markets, I suspect, is not that May had to cancel the vote. After all, she was obviously going to lose, and markets knew that.

However, the way in which she cancelled the vote does make her look weaker. It shows that she was miles away from getting a deal that MPs would back. So this isn't a case of getting a knock back, then going back to Brussels for a bit of a spit and polish on the deal, and coming back to win a second vote.

It's going to take a lot longer than that, and it also opens up the scenarios that the market doesn't like. All of those scenarios are a little bit more likely now than they were beforehand. What do they include?

The scenario that really scares the market

Firstly, there's an increased risk of "no deal". At the end of the day, financial markets would much prefer it if Britain had decided to stay in the European Union (EU) which does, incidentally, go to show you why you can't run a society by the dictates of financial markets alone, which is another reason for the current discord.

The fact that May can't apparently get her deal through parliament suggests that the odds of "no deal" have risen. You can certainly argue that the odds on remaining have risen too there's now more chance of an election or a second referendum outcome. But it's that increase in uncertainty that has helped to unnerve markets.

Secondly and probably more importantly there's an increased chance of May getting kicked out. If May steps down or is forced to step down as prime minister, that increases the danger that Jeremy Corbyn gets his shot in the hot seat and that's what markets are really nervous about.

I realise it can sound as if I'm horribly biased against Corbyn, and I'll make no bones about the fact that I think he'd be a disaster. I don't hide my opinions from you because as far as I'm concerned, that means you can then take my views with whatever pinch of salt you think they require.

But I don't think I'm being unfair here in terms of how the market perceives Corbyn.

Basically, markets have spent a lot of time thinking about a "no deal". It's still not entirely clear what it would mean. But analysts have been researching and companies have been preparing, and there has been a fair bit of time to do so. It's roughly possible to prepare a set of scenarios that will give an institutional investor an idea of what "no deal" might look like.

But "wargaming" a Corbyn government is trickier because no one is entirely sure what they'd do. There is, however, a reasonable assumption of hostility towards financial markets and the prospect of a somewhat cavalier attitude towards property rights.

So where does that leave investors?

Honestly, I think markets have overreacted here. Stocks are cheaper than they were a week ago and I thought they were cheap then, too.

I don't know where the bottom for the pound is, but I know it's cheap. I don't know where the bottom for the market is, but I know it's perfectly reasonable value and that a lot of the dividends on offer are sustainable.

I've been looking at shifting my pension asset allocation in the New Year to be more heavily weighted towards the UK, and I see no reason to adjust that plan.

bid for your chance to have a long chat with MoneyWeek editor-in-chief Merryn Somerset Webb and FT Money editor Claer Barrett here


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