Great Britain’s momentous vote to leave the European Union caught everybody by surprise, and I mean everybody! Let this be a lesson to the market timers and soothsayers who claim clairvoyance. The markets are usually pretty savvy about moving before the news but they got caught flat footed on this one. The pollsters as well as the betting websites also missed the boat.
What was not missed was the reaction of the markets which swung violently with European bourses falling by double digit amounts in a single day. The U.S. markets were down a fraction of that but still off a significant 3-5% over the first couple of days of trading. With the European markets up 2.5% after the 2 day dive, what can we learn about all of this madness?
First, never discount the possibility of insanity from happening. Harkening back to the financial crisis of 2008, then Fed Chairman Alan Greenspan was questioned by legislators about what if anything surprised him about the financial crisis. His response was that the Fed held a loose reign on regulation because he believed that the banks would always act in their self interest and never blow themselves up. SURPRISE! Apparently the same thing happened with the Brexit vote. Now that some of the exiters seem to be having second thoughts, the cost of their vacations just went up by 12% due to the devaluation of their currency; many seem to have voter’s remorse.
So we have two examples of usually rational people, U.S. bankers and the Brits, who historically have been quite rational, acting irrationally; and not just a handful of people, but mass irrationality. Apparently this behavior is part of the human condition.
Financial markets will react violently in the face of irrationality. It’s not important to know the whys and wherefores; this is their textbook reaction to uncertainty. We also know that in most cases these violent reactions are temporal in nature. The weirdness of the stock market is that over the short term it can be the evil Mr. Hyde and over the long term it is Dr. Jekyll. It’s irrational, just like us.