Why the latest bout of volatility is unnerving investors

Politicians resort to rationality only after exhausting all other possibilities, so history reminds us. Before that point, their actions can play havoc with financial markets.

Last week’s Italian turmoil and Trump’s trade wars are only the latest examples of how the world is sliding into competitive and angry populism, threatening old certainties on trade, security and co-operation – with far-reaching consequences for investors.

After the initial sugar highs, populist policies fail under their own contradictions. Yet, financial markets have always been poor at pricing in their impacts until they actually happen.

The reason is that their implied risks have too many moving parts: politics, economics, finance, security, diplomacy and psychology, to name a few.

The average investment analyst can only assess how economic variables affect the markets, but not how politicians will react to events that shape these variables in the first place. The zigzags evident in Italy and the US last week are a case in point. The end-game is anybody’s guess.

Just as intractable is knowing whether any bout of the resulting volatility is an opportunity to buy or sell. This is especially so, as the current over-valued equity bull market – in part fuelled by central bank largesse – is within spitting distance of being the longest in history.

With central banks no longer able to act as circuit breakers during periods of financial stress, investors fear that every correction may well be the tremor before the Richter scale goes ballistic. After the rollercoaster rides so far this year, markets have calmed. But their fragility is on the up: more adrenalin-fuelled sessions lie in store.

If you are interested in how investors’ sentiment towards market volatility has changed, and are a subscriber to the FT, please see my article in this week’s FTfm.

As always, I welcome your comments.

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