Trapped in a privileged bubble, markets can’t feel winds of political change

LONDON (MarketWatch) — The pound is sailing up past $1.60. The FTSE-100 index is breezing past 7,000. The euro is strengthening, and business confidence is gaining ground across the continent.

A raft of M&A deals, and a few big initial public offerings are unveiled as the investment bankers push forward with deals that had been kept on hold until the uncertainty resolved itself. And British Prime Minister David Cameron is pictured disappearing off to the Mediterranean to enjoy a well-earned break.

Many investors must be hoping that somehow they can wake up from a very bad dream and get on with their lives in a world where the U.K. had decided to stay in the European Union.

That, as we now know, is not what happened. Instead, while the FTSE UKX, -1.52%   has been surprisingly buoyant, sterling GBPUSD, -0.9675%  has been plunging, and there is already plenty of evidence of deals being pulled, and a damaging hit to business confidence.

The worrying point for investors, however, is not just that they didn’t get the result they wanted. It is that they read the British referendum so completely incorrectly — and convinced themselves that the Remain side would eventually win.

That is hardly the first time that has happened. The markets got the 2015 election in Britain upside down as well. They didn’t think that Donald Trump would ever be the Republican nominee. They read the Spanish elections last month incorrectly, and the Austrian elections as well.

An accident? Perhaps. After all, these things are intrinsically difficult to predict. But it is also possible that something more fundamental is happening — that investors have become completely unable to predict political changes.

There are two compelling reasons why that might be the case. One is that the polls have become far less reliable than they were in the past. The second is that traders and fund managers live within a privileged bubble and have little contact with angry voters who are driving populist insurgencies across the world.

If either is true, they need to fix that — and fast — or else they are going to carry on losing huge amounts of money.

If you wind back a couple of weeks, the markets were largely convinced that the U.K., after a toughly fought campaign, would vote to stay in the EU. All through the week leading up to the vote, sterling steadily strengthened against the dollar. On the night of the vote itself, as the last polls were released, and private surveys digested by currency traders, sterling jumped to $1.50. And yet — as the actual ballot papers were counted and the result turned out to be very different — the currency suddenly went into free fall, and has remained under pressure ever since.

A few very smart people may have made money through that extreme volatility — Winton Capital, ironically run by a leading Remain supporter, is reported to have made $1 billion from trading on the outcome of the vote.

But most investors will have lost out, and a few badly so.

There are always going to be upsets, but there is also growing evidence that it is getting harder and harder for the markets to get any real handle on political trends. If I had a pound for every note from a research house reassuring everyone that Donald Trump was just a flash in the pan, and the grownups would soon be back in charge of the Republican Party, I would be feeling a lot richer.

Very few “experts” saw him taking the nomination. Last year, the mainstream view was that Britain would have a hung Parliament, and the coalition would endure, which would have meant no referendum. Investors thought the far-left Podemos would make gains in Spain last month, but that turned out to be wrong, and so have predictions for elections in Austria and Poland.

In reality, politics has become far less predictable.

One reason is that opinion polls have become less reliable. There were only off by a few points on the U.K. referendum result. But that was enough to make the difference. There is mounting evidence to suggest that polling is growing less useful.

That might be because the demise of landline phones means it is harder to reach people. It might be because voters are more media-savvy and lie more often. It might be something else. Whatever the reason, it appears to be the case. The markets need to start taking that into account. Unless one side has a clear 10-point lead in the polls, you can’t take anything for granted — and perhaps not even then.

The second reason is more serious. The people who actually make up the markets are bankers, brokers, fund managers, journalists, and well-off private investors. They are all inside a prosperous bubble. The people who are left behind are somewhere else. They don’t have a voice in the markets because they don’t have any money to invest (which is, of course, part of the problem).

As political battles across the developed world become increasingly a contest between the winners and losers from globalization, the markets have become more and more clueless. One reason most people thought Remain would win was because in the City, and in most of London, you didn’t encounter any Leavers.

Likewise, you don’t meet any Trump supporters on Wall Street or in Washington. The people inside a well-off bubble can’t read the political mood at all — because they have no idea how people outside that world feel.

As populism becomes stronger and stronger, and as revolts against elites grow in force, the markets need to get better a handle on that. They need to understand that a lot of their fellow countrymen don’t live as comfortably as they do, and don’t have the same kind of opportunities.

Many are struggling to get by on minimum wages and facing intense competition for their jobs from migrants who will work for less. If they don’t start to understand that, they will keep getting blind sided — and will end up losing fortunes in the process.