And that seems to be the premise under which financial markets have been labouring in the first half of the year, with the result being so-called risk-free assets are trading at values we consider unrealistic.
As a history and philosophy buff, I recognise the response of financial markets to the events of 2016 as classic Hegelian behaviour: initial assumptions proved wrong so consensus immediately swung to the opposite extreme.
In early 2016, few observers were giving much credence to the possibility of a UK vote to leave the European Union (EU), or the possibility of Donald Trump triumphing in the US presidential election.
But when those events did happen, the response was to assume that every subsequent populist eventuality was now in play, no matter how unlikely. That attitude led risk-free assets, such as core government bonds, to trade at a very significant premium.
In fact, the Hegelian Dialectic, which this behaviour reflects, also implies there will be an eventual resolution of the two extremes. That’s largely my interpretation of the outlook for 2017, which is why I’m taking a more sceptical view of the valuations of so-called risk-free assets.
Dutch election paranoia
Amid the paranoia in markets and the media as we approached the Dutch elections in March, we saw a widening of spreads in European government bonds, driven in part by the huge amount of airtime dedicated to whether the far-right politician Geert Wilders could actually win the election.
In truth, that probability was very small given the way the Dutch electoral system works.
Equally, it should be absolutely no surprise that Marine Le Pen made it through to the second round of the French presidential election. But again, the probability of her winning was negligible.
Even if she had won, it would have been extremely unlikely that she’d have been able to garner enough votes in the National Assembly to deliver on her populist agenda.
German election
As we look forward to the rest of the year, a number of commentators are getting excited about the potential disruption that an unexpected result in the forthcoming German general election could cause.
In our view, the result, however it plays out, is not going to change the fundamental pro-European, German consensus style of politics. And that shouldn’t change the fundamentals of how Europe is going to be governed.
So the argument that investors should confine themselves to risk-free assets because the world is on the brink of adopting a swathe of radical fiscal and monetary policies or because we’re facing the prospect of the break-up of the EU, seems to me to be specious.
Growth is the real concern
The real concern is that the support for populist politicians such as Wilders and Le Pen marks the fact that growth isn’t as strong as it should be. There’s a populist disenfranchised constituency that is prepared to vote for such far-right candidates to break the status quo.
My view is that overcoming that sense of disenfranchisement should not be just about politics, but about economics.
And the signs are positive. The International Monetary Fund (IMF) has upgraded its global growth forecast, while latest figures indicate that eurozone growth of 0.5 per cent in the first quarter of 2017 was stronger than in the US.
So, where does that leave us? In our view, the US Federal Reserve (Fed) is likely to continue to raise interest rates. While the European growth figure possibly slightly flatters the real picture, we’re taking the improving trajectory as a positive sign.
Against that background, we don’t think the recent yield of around 0.3 per cent for German 10-year government bonds makes a whole lot of sense, even factoring in uncertainties over Brexit negotiations and further European elections.
Greater stability on show
Risk-free assets are priced for political paroxysms, and yet we’re seeing far greater degrees of stability than some commentators had been predicting. Therefore, we expect to see a shift in relative pricing.
That’s not to say that we think everything in the garden is rosy. We remain concerned that unless there is an improvement in economic growth, employment and general well-being over the next three to four years, a turnaround in the fortunes of populist figures such as Le Pen is possible.
In the meantime, we are looking for a return to the political status quo. With that, we would expect the shock to dissipate, risk-free assets to cheapen and the market’s focus to return to economic fundamentals.
John Beck is Franklin Templeton's director of fixed income in London and senior vice president of the Franklin Templeton fixed income group.
