How strange it is to be a British investor on the cusp of your country leaving the European Union.
The closer we get to us waving bon voyage, the higher our portfolios go.
Even the biggest Euro-sceptics must surely admit some surprise at seeing their portfolios swell to all-time highs. While there was plenty of pre-vote debate about the long-term consequences of Britain leaving the Union, there was a near-consensus that things would be choppy to begin with.
True, even little old me predicted that the pound would probably fall if Britain voted for Brexit – and I pointed out on the Fool that this would likely bolster the attractiveness of the FTSE, as it would boost the already substantial revenues and profits that our biggest companies earn overseas.
But the key word was “bolster”.
I expected a weaker pound to be a pro that could offset some of the cons, resulting in a muddle-through scenario.
If you’d told me in February – when the FTSE 100 was already down more than 10 per cent for the year – that we’d vote to Brexit, I freely admit I’d never have guessed the index would now be up 12 per cent in 2016.
The iShares FTSE 100 ETF is 14.5 per cent higher for the year on a total return basis.
If only we could have a constitutional crisis every summer!
Fifty shades of grey
Of course, predicting short-term market swings is a mug’s game, as we always like to remind ourselves.
Everyone is wise after the fact. People now say that there was never any risk of a systemic reaction to the Brexit vote, or of more than a wobble on the UK market. The risks were overblown. The market has other things to worry about.
And the weight of evidence so far is on the side of such hindsight geniuses.
But I would caution against complacency.
Not only is there still plenty of uncertainty out there in the wider world – the US is having its own little election soon, with similar potential to upset the applecart, for a start – but we don’t really know what the impact of Brexit will be.
What we do know is that when Theresa May declared she would trigger Article 50 by March next year, the pound began to fall again.
A sliding currency might be good for multinational shares, but it hardly seems like a ringing endorsement of our economy.
I’ll offer another signal that has me believing that fear – or at least uncertainty – more than excitement is what’s really driving these big investment returns right now.
And that’s the behaviour of the UK government bond – aka gilt – market.
Gilts have followed many years of strong returns, with yet another good showing in 2016.
In fact, the iShares Core UK Gilt ETF has delivered very nearly a 15 per cent return year-to-date. It’s done better than the FTSE 100.
Okay, you say, that’s not a big surprise. The Bank of England cut interest rates in the wake of the EU Referendum. If expectations for economic growth, rates, and inflation are now lower than they were, it makes sense for super-safe fixed income issued by the Government to be higher...
…only there’s a snag with that theory, which is that index-linked gilts – which provide investors with protection against inflation – have delivered even stronger gains in 2016, and more than shares, too.
In fact, £100 invested in the iShares Index-Linked Gilts ETF would be now worth £131.
That’s a gain of over 30 per cent in less than ten months.
Brexit means… be prepared
It’s all somewhat perplexing.
What we can say is that both conventional and index-linked gilts entail no credit risk, because it’s presumed the British government will always pay its debts. As such, they’re the ultimate safety investment.
Strong returns from gilts might therefore suggest investors have become very fearful – especially given that predicted returns from both conventional and index-linked gilts were around all-time lows even before this latest move, so they hardly looked attractive.
But that view of investors is at odds with the strength in the stock market.
Moreover, it’s not clear to me how an environment that would be good for index-linked gilts – that is, many years of higher-than-expected inflation – could also benefit conventional gilts.
With their fixed coupons, the latter should become less attractive if inflation erodes their real returns.
It’s true that other factors are at play – the Bank of England’s ongoing monetary programmes for one, and also escalating pressures on pension funds as a result of the falling discount rate, which may be forcing them to buy ever more gilts to compensate for the resultant deficits.
But those factors are not totally new to 2016.
Again, I wish I had a confident theory that explained exactly what was going on. Sadly, I don’t.
What I can suggest is that we all stay alert, cautious, and keep diversified in the face of such unusual market moves – and such unusual times.
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