What a spectacular lesson the first half of the year delivered for investors. At the beginning of the year, it looked like the UK’s vote to leave the European Union was a great idea: the eurozone seemed on the brink of disintegration.
But then we had the result of the Dutch election in mid-March — people rejected populists – and of the French election in May – again, people rejected extremism and voted for a relatively fresh-faced centrist.
In June, the snap election called by UK Prime Minister Theresa May seems to be her undoing. Her Conservative party lost the majority it had, and now it looks like Brexit negotiations will get harder, not, as May was hoping, easier.
For investors, and probably for politicians, the lesson is to never take anything for granted. The eurozone, on which a lot of institutional investors had given up until not long ago, is now the preferred destination for many fund managers.
By contrast, UK equities and the pound are among the least favourite destinations for investors, and could remain so for a while.
Another important lesson was buried under the more exciting political news: Bond bears seem to have capitulated.
They have understood that liquidity remains high and growth remains low, which means bonds are not such a bad investment after all.
In the latest week, bonds saw the biggest inflows in 122 weeks, $16 billion in total. These were in anticipation of the risks in a news-heavy week: besides the UK election, last week also saw former FBI head James Comey testify in Congress, and the European Central Bank removing its downside bias from its growth outlook.
Comey’s testimony increases the odds that an impeachment of President Donald Trump is more likely, so investor flight to the safety of bonds is normal.
However, the ever-so-slight removal of dovish rhetoric from the ECB draws the moment when the flow of liquidity slows down closer.
Normally, this would be bad for bonds. But the debt market seems to try to teach investors another lesson.