FTSE left frozen in the headlights by coin toss of a vote

If your only guide to what’s going on in the world were a chart of the FTSE 100, you’d be forgiven for thinking nothing was happening at all. You’d be hard pressed to discern any evidence that the UK was going through an existential crisis. The market is pretty much where it was two weeks ago.

That’s interesting because it is generally accepted that markets hate uncertainty. You might have expected the stock market to have reacted extremely negatively to the potential economic, political and constitutional dislocation that Thursday’s referendum might bring. But it appears to have shrugged it off.

Actually, it is a bit more complicated. Firstly, different markets have reacted in different ways to the possibility of a Yes vote for independence. Unlike the equity and bond markets, the currency market has been volatile because a Yes vote would appear bad news for the pound. The loss of oil revenue would have a detrimental impact on the UK’s balance of payments and the likelihood of 18 months of uncertainty would increase the risk of holding UK assets.

The main economic uncertainty about independence – which currency Scotland would use – is understandably weighing on sentiment towards sterling. Investors demand a premium to compensate them for both known risk and uncertainty, which itself increases the chance they might be affected by unknown risk. That makes the depreciation of the pound a reasonable outcome (that will probably reverse in the case of a decisive No vote, although not if the result is close and threatens further uncertainty to come). What it doesn’t answer is why the equity and bond markets have not really reacted.

Investors are good at weighing up probabilities when there is an obvious imbalance between the likelihood of outcomes. For example, we know that if you hold equities for 10 years or more there is about a 90pc chance that you will outperform both bonds and cash. Armed with that knowledge, you can make a decision about how to allocate your assets. Where markets become frozen in the headlights is when they are faced with a binary outcome like Thursday’s vote. The positioning that makes sense for a Yes vote is exactly what won’t work if the Noes have it, which suggests there is no rational approach other than what you would have done anyway in the absence of a vote. Betting for or against the banks, oil companies, retailers and all the other companies that will be affected by the vote is a coin toss if the polls are stuck at 50:50. That makes the lack of market movement completely sensible.

Another reason markets are static is that the obvious negatives — the impact on consumer spending of higher taxes and lower government spending, businesses’ unwillingness to spend and invest in an uncertain environment – are offset by two very obvious positives from the events of the past week.

First, all those companies that spent the summer complaining about the strength of the pound might suddenly be up to 10pc more competitive. For shareholders that means not just higher profits but probably better dividends too.

Second, the prospect of a year and a half of uncertainty makes interest rate rises a bit less likely, or at least delays them. For the gilt market, any possible reduction in the UK’s creditworthiness is offset by the likelihood of slower growth than would otherwise have been the case and lower interest rates. Both of these are likely to keep Government bond yields well anchored close to today’s levels.

Markets are notoriously bad at pricing in, or indeed even acknowledging, tail risks – events with low probability but significant impact. Even if they had attempted to price in a Yes vote they might simply have ended up in exactly the same place.

Sometimes it can be very hard to identify important events on a historic share price chart. I wouldn’t be surprised if the 2014 Scottish referendum were one of these invisible market events.

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