The View | Curb your enthusiasm

The following things happened in the wake of Scotland's decision to remain in Britain: share prices in London rose by less than 1 per cent, the value of sterling against the dollar rose by 0.3 per cent and yields on government bonds rose - but this was mainly because investors expected the Bank of England to move aggressively on rates, something that did not happen.

Or to put it another way; after the Scottish referendum, the perennially excitable financial markets carried on with business as usual. Yet before the vote there were dire warnings of what would happen if Scotland left the Union and there were a slew of optimistic predictions for the favourable outcome of a "yes" vote. When the result was known, the mighty financial markets registered little more than a collective shrug.

As a cub financial reporter, I was much impressed by the often-repeated notion that markets, in their infinite wisdom, had the ability to foresee and thus discount major political and economic events. This suggested a form of omnipotence for collective market wisdom. However, I have come to understand that there are far better explanations for the way markets respond to events and now appreciate that they hardly suggest omnipotence, nor, for that matter, good sense.

First, as Keynes frequently observed, markets have a herd-like mentality and thus can produce self-fulfilling prophecies. Thus if, for example, collective market "wisdom" determines that the political situation in Britain is unstable, there will be an outflow of funds.

In fact, seven days before the Scottish referendum, international fund managers pulled some US$1 billion worth of equity investment out of the country. Shares were accordingly marked down in price. Thus it may be argued that the market was "right". However, we now know that the assumption for this outflow - that Britain was in danger of dissolving - was wrong.

Second, market makers and investors nearly always tend to favour the status quo and assume change is likely to be detrimental to their investment interests.

This is why we are often told that markets prefer continuity at election time. However, the overwhelming bulk of studies conducted in mature democracies show that in itself a change of leadership produces very little change in the fortunes of markets. Some new leaders - former British prime minister Tony Blair is a good example - have better luck than others and preside over a better investment climate, which turns out to have emerged without their intervention.