Rise in FTSEs despite Brexit uncertainty

[TheMotorcycleBoy]

From my minutes each day spent in the car listening to R4, it seems certainty re. Brexit is no closer for us as a nation. The last I heard was the EU stating to Theresa "Sorry love, we've done the best we can - a deal's a deal".

But the FTSEs 100 and 350 seems to have risen about 3.5-4.0% in the last month....

So people (who have much more experience at this investing thing than me), how can this be?

1. Is Mr. Market just feeling very happy watching snowdrops bloom, as he munches away at his last Christmas chocolates?
2. Is it because people are speculating on a Brexit deadline push back?
3. Just a seasonal thing?

Falling back on our 11 months experience of investing, I'm guessing that it's combination of all three of the above. Anyone have any other thoughts?

Matt

[TUK020]

Don't equate FTSE100 with the UK economy.
About 70% of FTSE100 earnings are overseas.
Brexit bad news = sterling goes down = s.p. of companies with ,$earnings (RDSB, BP, GSK) or Euro (ULVR) goes up.

[SalvorHardin]

Markets have a habit of pricing things in well before the event. They are telling us that the pundits' predictions of economic armageddon are wrong. Either there will be a reasonable deal, or a no deal exit won't be calamitous. Of course markets have been wrong in the past, notably about the original Brexit vote.

Many investors consider markets to be far more credible than pundits because people are placing their money and/or jobs at risk. In contrast pundits generally don't get held to account when their predictions are hopelessly wrong.

Macroeconomic forecasts are particularly prone to being wrong. The media (and many people who should know better) makes things worse by treating them as scientifically accurate, whereas they make astrologers seem sensible. Remember the prediction that a vote to leave the EU would cause a recession in the second half of 2016 as well as stockmarket and house price crashes and unemployment rising by up to 1 million? Totally wrong.

These forecasters are generally not called to account for their massive errors (except by people like me who routinely laugh at them).

As TUK020 has pointed out, the FTSE100 doesn't really reflect the UK economy. The FTSE250 is a much better proxy. As is the sterling-US dollar exchange rate (followed by sterling-Euro).

A good example is the central London property company Derwent London, whose shares are up 15% in 2019. The central London property specialists are an excellent proxy for Brexit sentiment amongst investors - they were hammered after the 2016 vote but have recovered strongly. I own shares in three of them (Derwent London, Great Portland Estates and Shaftesbury - all three are in the FTSE250)

[TheMotorcycleBoy]

Markets have a habit of pricing things in well before the event. They are telling us that the pundits' predictions of economic armageddon are wrong. Either there will be a reasonable deal, or a no deal exit won't be calamitous. Of course markets have been wrong in the past, notably about the original Brexit vote.

Yes. That is what is currently making sense to me.

Macroeconomic forecasts are particularly prone to being wrong. The media (and many people who should know better) makes things worse by treating them as scientifically accurate, whereas they make astrologers seem sensible. Remember the prediction that a vote to leave the EU would cause a recession in the second half of 2016 as well as stockmarket and house price crashes and unemployment rising by up to 1 million? Totally wrong.

I'm tending to agree more and more to such sentiments these days.....i.e. although I do have R4 on in the car on the way in (mainly to stop me listening to rock music instead, which makes me drive like a loonie!!), a lot of times I tend to let the doom and gloom stuff wash over me without much attention.

These forecasters are generally not called to account for their massive errors (except by people like me who routinely laugh at them).

As TUK020 has pointed out, the FTSE100 doesn't really reflect the UK economy. The FTSE250 is a much better proxy.

To be fair FTSE250 looks like it had a bigger rise (3 Jan=17400ish 2 Feb=18800ish) about 7%.

As is the sterling-US dollar exchange rate (followed by sterling-Euro).

Salvor, do you mean like this Salvor:

https://www.xe.com/currencycharts/?from ... SD&view=1M

i.e. 1.26 ($ per £) at Jan 3, and 1.30 at Feb 2, i.e. 3% rise.

So (out of interest) what kind of things is +7% for the FTSE250 and +3% on $per£ telling us?

many thanks Matt

[SalvorHardin]

Salvor, do you mean like this Salvor:

https://www.xe.com/currencycharts/?from ... SD&view=1M

i.e. 1.26 ($ per £) at Jan 3, and 1.30 at Feb 2, i.e. 3% rise.

So (out of interest) what kind of things is +7% for the FTSE250 and +3% on $per£ telling us

Yes. The sterling - US dollar spot exchange rate is an excellent proxy for how the world views Britain's economy (relative to the USA). On the day after the Brexit vote sterling fell by around 10% against the dollar, which was the market telling the world that it thought that the eventual outcome would be terrible for the British economy.

The strength of the pound and the FTSE250 in 2019 are telling us that the markets' view is that the economic outlook for the UK domestic economy has improved since 2018. Now this doesn't necessarily mean that this is all because of an improving Brexit outlook. For example, the Italian recession (and probable German recession) will have made investors look on Britain a bit more favourably.

Markets are always looking ahead. This often surprises many pundits (who should know better). Very often a significant event doesn't produce a corresponding move in asset prices because the news has already been priced in. A common example is a company producing a set of excellent results, only to see its share price fall. This is because the market was expecting these figures (and a bit more) so had built these expectations into the share price over the past few months.

Always remember that bad news sells better than good news. You may have noticed that big stockmarket falls generally feature in the main news headlines, whereas big rises only headline the specialist financial news bulletins.

Pundits trumpet their successful forecasts whilst pretending that their numerous failures never happened. Lots of pundits have made a career out of one successful prediction, which will invariably be mentioned when they are interviewed (but not the ones which were wildly incorrect).

[TheMotorcycleBoy]

Salvor, do you mean like this Salvor:

https://www.xe.com/currencycharts/?from ... SD&view=1M

i.e. 1.26 ($ per £) at Jan 3, and 1.30 at Feb 2, i.e. 3% rise.

So (out of interest) what kind of things is +7% for the FTSE250 and +3% on $per£ telling us

Yes. The sterling - US dollar spot exchange rate is an excellent proxy for how the world views Britain's economy (relative to the USA). On the day after the Brexit vote sterling fell by around 10% against the dollar, which was the market telling the world that it thought that the eventual outcome would be terrible for the British economy.

The strength of the pound and the FTSE250 in 2019 are telling us that the markets' view is that the economic outlook for the UK domestic economy has improved since 2018. Now this doesn't necessarily mean that this is all because of an improving Brexit outlook. For example, the Italian recession (and probable German recession) will have made investors look on Britain a bit more favourably.

Markets are always looking ahead. This often surprises many pundits (who should know better). Very often a significant event doesn't produce a corresponding move in asset prices because the news has already been priced in. A common example is a company producing a set of excellent results, only to see its share price fall. This is because the market was expecting these figures (and a bit more) so had built these expectations into the share price over the past few months.

Always remember that bad news sells better than good news. You may have noticed that big stockmarket falls generally feature in the main news headlines, whereas big rises only headline the specialist financial news bulletins.

Pundits trumpet their successful forecasts whilst pretending that their numerous failures never happened. Lots of pundits have made a career out of one successful prediction, which will invariably be mentioned when they are interviewed (but not the ones which were wildly incorrect).

Thanks Salvor - interesting stuff.

I guess another possible factor in the UK's favour (against rest of world), could be markets "pricing in" no further corp. tax cuts over in the US, and possible negativity over there as the Trump boom loses it's oompph.

[WorkShy]

The rise in GBP/USD is mainly due to the market's assumption that the probability of a "no-deal" or "hard" Brexit has fallen in the last month. As the probability attached to this tail scenario has fallen, spot GBP/USD has naturally risen. The magnitude of this reduction in tail probability can be best observed by looking at the GBP/USD option market. As can be seen on the chart in this link https://uk.investing.com/currencies/gbp-usd-options the implied volatility of a 10 delta (think of it as a 10% probability) GBP put/USD call (the right but not the obligation to sell GBP and buy USD) has fallen from around 16% to under 13% over the last month, a very substantial drop. If you look at what is term the "10 delta risk-reversal" (the difference in implied volatility between a 10 delta GBP/USD call and 10 delta GBP/USD put) then you will also see that the relative price of calls has risen vs. that of puts. This shows that the skewness of the implied probability distribution for GBP/USD has moved toward implying a higher GBP/USD forward value.

With regards to the FTSE. Obviously, a lower implied probability of no-deal with tend to support domestic equity prices (FTSE250). Most stock markets, however, have risen this month due to the Fed pulling back on the likelihood of further monetary tightening and balance sheet reduction. China has continued to add stimulus and the ECB has implied that the end of QE may be put back and any limited rate rises are now for 2020, not the end of 2019. All risk positive.

[TheMotorcycleBoy]

The rise in GBP/USD is mainly due to the market's assumption that the probability of a "no-deal" or "hard" Brexit has fallen in the last month.

I sort of agree that this a reasonable enough interpretation. But in the last few days, what I've heard from my very limited exposure to Radio 4 news (see my OP) is that the EU aren't budging on the Brexit Agreement "finalised" late last year, and since our MPs gave this the thumbs down says to me that the probability of "no-deal" or "hard" Brexit is still quite high.

I'm thinking what's more likely is a push back of the Brexit has been "priced in".....so I assume Mr. Market is being a rather hopeful fellow of late, and maybe we will get more volatility, that is, as we approach March 29th and the market spends a fortnight or so pondering "no-deal" Brexit or delayed Brexit.

Just my thoughts - live from a crystal ball.

[WorkShy]

I forgot to add but I agree that another reason why GBP/USD has risen is that the market perceives a higher probability of "can-kicking" with regard to Brexit.

I try not to get too bogged down with modal macro views (I have a fairly dim view of economics and macroeconomics, in particular) and instead stick to the easier approach of simply buying cheap probability and selling expensive probability. The market assumed that the run up to Brexit would generate a high volatility in GBP/USD and, as a result, implied volatility rocketted. In reality, what actually happend was that realized GBP/USD volatility collapsed as spot became paralysed between the positive and negative scenarios. The recent range of 1.25 to 1.32 is something that could have easily be observed without any Brexit issues. Say just due to changes in DXY, the US dollar index. We went from 1.30 to 1.42 in a few month early last year just on dollar weakening, for example. Now that implied volatilty has mean-reverted back to less extreme levels, it may offer some value. Tails do seem somewhat cheap again.

[TheMotorcycleBoy]

[quote="WorkShy"] and instead stick to the easier approach of simply buying cheap probability and selling expensive probability.[/quote]
Yes, me too. Indeed, I'd been hoping for another cheaper buying opportunity like we had in December. But I'm guessing that's more likely as mid March pans out.


[quote="WorkShy"]Tails do seem somewhat cheap again.[/quote]
Ok. Help me out here please. What do you folks mean exactly, by "tails" ? Is it like "tail risk"?

Another term I'm yet to grasp.......and how does this term relate to the current scenario?

Many thanks, Matt

[odysseus2000]

Hi Workshy,,

Just as a point of understanding as I don’t trade options, but looking at your chart

https://uk.investing.com/currencies/gbp-usd-options

the put delta read on the x-axis seems to have gone (red curve) from over 14% to under 12% (blue curve) in a month.

Not as you state from around 16% to under 13

Am I reading this wrong?

Regards,

[WorkShy]

the put delta read on the x-axis seems to have gone (red curve) from over 14% to under 12% (blue curve) in a month.
Not as you state from around 16% to under 13
Am I reading this wrong?
Regards,

My fault. For some reason the link defaults to 1-month expiries, when I was looking at 3-month expiries. The three month expiries include Mar-29th so are a better indicator than 1-month that expires before.

[odysseus2000]

Ok

Thank you for the explanation.

Regards,

[WorkShy]

Tails do seem somewhat cheap again.

Ok. Help me out here please. What do you folks mean exactly, by "tails" ? Is it like "tail risk"?
Another term I'm yet to grasp.......and how does this term relate to the current scenario?
Many thanks, Matt

Tails are simply low probability outcomes (as in the 'tails of the probability distribution', those part of the distribution to the far left or far right of the central tendency). How 'low' is low is rather arbitrary but <10% and possibly <5%.

So the probability that GBP/USD is above 1.42 over the next 3 months is priced at around 10% or about 10:1 in simple betting terms. Only a month ago, with GBP/USD spot lower at say 1.27 (vs. the current 1.31), it was priced at 15%. So even though we are closer to 1.42 than a month ago, the market has reduced the probability we can rise to 1.42 because it's reduced the probability attached to larger moves or tail events.

In the last month, we've observed the implied volatility attached to many assets fall substantially. Not only has the markets expectation of volatility fallen, but the market's expectation of tail events has fallen aswell (the volatility of volatility as it is known). This is mainly down to a higher expectation of secular stagnation in the global economy. As implied volatility has fallen, asset classes have risen (both bonds and equities). Markets hate uncertainty and implied volatility is a measure for that, so as volatility falls, asset prices rise.

It might seem counterintuitive but the market's assumption of lower global growth (secular stagnation) is causing equities to rally because a) major central banks will not tighten liqudity as much b) this reduces the risk of policy errors that cause recession c) this is an ideal environment for the "carry" trade. Broadly speaking the "Fed put" is back on the table and the market likes that. Whether that is really true is another question.

[TheMotorcycleBoy]

Thanks for this, Workshy, this is a nice answer,

Tails do seem somewhat cheap again.

Ok. Help me out here please. What do you folks mean exactly, by "tails" ? Is it like "tail risk"?
Another term I'm yet to grasp.......and how does this term relate to the current scenario?
Many thanks, Matt

Tails are simply low probability outcomes (as in the 'tails of the probability distribution', those part of the distribution to the far left or far right of the central tendency). How 'low' is low is rather arbitrary but <10% and possibly <5%.

A ha, I get it. Probabilities and distributions of. Alas, I took "Mechanics" in my A level maths, not Stats. So perhaps I may swot up on stats sometime out of curiousity. I did, however, glance at a couple of wikis e.g. https://en.wikipedia.org/wiki/Fat-tailed_distribution
e.g.

The Black–Scholes model of option pricing is based on a normal distribution. If the distribution is actually a fat-tailed one, then the model will under-price options that are far out of the money, since a 5- or 7-sigma event is much more likely than the normal distribution would predict.

So the probability that GBP/USD is above 1.42 over the next 3 months is priced at around 10% or about 10:1 in simple betting terms. Only a month ago, with GBP/USD spot lower at say 1.27 (vs. the current 1.31), it was priced at 15%. So even though we are closer to 1.42 than a month ago, the market has reduced the probability we can rise to 1.42 because it's reduced the probability attached to larger moves or tail events.

Ok sure. But presumably, the further increases in the $ per £ are priced in, since the FTSE 250 rose by 7% in last 4 weeks (vs GBP/USD rise of 3%), so people are still thinking of an improving UK (vs US) economy. Perhaps, or have I got that wrong?

In the last month, we've observed the implied volatility attached to many assets fall substantially. Not only has the markets expectation of volatility fallen, but the market's expectation of tail events has fallen aswell (the volatility of volatility as it is known). This is mainly down to a higher expectation of secular stagnation in the global economy. As implied volatility has fallen, asset classes have risen (both bonds and equities). Markets hate uncertainty and implied volatility is a measure for that, so as volatility falls, asset prices rise.

It might seem counterintuitive but the market's assumption of lower global growth (secular stagnation) is causing equities to rally because a) major central banks will not tighten liqudity as much b) this reduces the risk of policy errors that cause recession c) this is an ideal environment for the "carry" trade.

Yup - makes sense.

Broadly speaking the "Fed put" is back on the table and the market likes that. Whether that is really true is another question.

Ok, you've lost me again. What's a Fed put?

[Spet0789]

A put is the right to sell an asset at a fixed price. So if you hold a put on an asset it limits your potential loss.

The ‘fed put’ is the belief that if equities drop enough, the fed will respond by lowering rates,
which will arrest the drop in share prices and so limit the loss.

Back on topic, just try to look through the day to day noise and see the signal. The markets (FX and U.K. Equities vs the rest of the world) think that Brexit will be very bad for the U.K. economy but not a cataclysm. That’s pretty much what I think too.

[TheMotorcycleBoy]

A put is the right to sell an asset at a fixed price. So if you hold a put on an asset it limits your potential loss.

The ‘fed put’ is the belief that if equities drop enough, the fed will respond by lowering rates,
which will arrest the drop in share prices and so limit the loss.

Back on topic, just try to look through the day to day noise and see the signal. The markets (FX and U.K. Equities vs the rest of the world) think that Brexit will be very bad for the U.K. economy but not a cataclysm. That’s pretty much what I think too.

Despite voting to Remain, and being a tad depressed about stuff re. our economy, I don't actually think it will be that bad economically. My rationale being that despite any thoughts I may have about why the Leave vote actually did go through, I am also fully aware that a lot of the Brexit backers were big-money-men and capitalist types (e.g. Rees-Mogg) and I don't think they would have been as eager to back the movement had they not had a belief in some £££ coming out of it. But of course if it (£££) does come, it will come as result of deregulation, lower corp taxes, and less "social" spending.

[odysseus2000]

MotorcycleBoy
Despite voting to Remain, and being a tad depressed about stuff re. our economy, I don't actually think it will be that bad economically. My rationale being that despite any thoughts I may have about why the Leave vote actually did go through, I am also fully aware that a lot of the Brexit backers were big-money-men and capitalist types (e.g. Rees-Mogg) and I don't think they would have been as eager to back the movement had they not had a belief in some £££ coming out of it. But of course if it (£££) does come, it will come as result of deregulation, lower corp taxes, and less "social" spending.

Some money could come from the mechanisms you suggest, but the big money has always come from growth. Carrying forward policies like you suggest as did Osborne and Cameron is almost guaranteed to lead to a back lash and put some business unfriendly guy in charge who believes in nationalisation etc.

I have no real idea what Rees-Moog et al want or expect but this is how I see things.

A post brexit UK has the opportunity to grow with the world's dynamic economies not shackled to a Europe which is currently run by folk who have no concept of secular growth.

Almost none of the popular 21st century wealth creating business are European.

If you contrast that with the US one sees great wealth creators in Apple, Google, Facebook, Netflix, Tesla etc. Even the coffee and fast food chains in Europe are predominantly US based. Why has Europe not got its own version of these?

Sure you can argue that German is prosperous which is true as the Euro is weak due to the effects of Greece etc. Without the weak Euro Germany would not have such profitable industries and meanwhile the flip side is that Greece is in a terrible mess as they need lower exchange rates but are stuck with the Euro which is high for them.

The whole approach of the EU has failed to produce the growth that the US, China. India etc are seeing and has set up major fault lines between the rich north and the poor south.

The EU politicians are so focused on the political unity that they are missing that Europe is declining almost as if their job is about managing what they have, like 1970's UK rather than growing. In the by and by such an approach will lead to big troubles as we discovered in 1970's UK.

Of course many folk disagree and argue that an integrated Europe is a strong and prosperous thing that no one in their right mind would want to leave, but that is not how I see it.

Regards,

[OhNoNotimAgain]

From my minutes each day spent in the car listening to R4, it seems certainty re. Brexit is no closer for us as a nation. The last I heard was the EU stating to Theresa "Sorry love, we've done the best we can - a deal's a deal".

But the FTSEs 100 and 350 seems to have risen about 3.5-4.0% in the last month....

So people (who have much more experience at this investing thing than me), how can this be?

1. Is Mr. Market just feeling very happy watching snowdrops bloom, as he munches away at his last Christmas chocolates?
2. Is it because people are speculating on a Brexit deadline push back?
3. Just a seasonal thing?

Falling back on our 11 months experience of investing, I'm guessing that it's combination of all three of the above. Anyone have any other thoughts?

Matt

It's noise, not even worth ignoring.

[onthemove]

Falling back on our 11 months experience of investing, I'm guessing that it's combination of all three of the above. Anyone have any other thoughts?

Another aspect I've not seen mentioned yet, is potentially Jeremy Corbyn's slipping in the polls relative to May.

A month or two ago it looked like if a general election were called, there would have been a real chance of a Corbyn government, and with that numerous problems..

1. He would still have ploughed on with brexit, without any further confirmation vote, etc
2. General labour socialist economic policies on their own, which are generally never great economically... but also
3. Nationalisation would be on the cards of utils, trains, buses, etc.
4. Confiscation of 10% equity in every UK based company with the prospect of why stop there? Why not let the owners own all companies? There was no talk of any 'purchase' of this equity - McDonnell seemed to expect it just to be set aside for free.

But just the past week or so, it looks like Corbyn's handling of May's deal getting rejected (like refusing to talk with May initially, etc), has resulted in Corbyn losing significant support.

There's even now resurrection of talk of a centre ground party being created as a result of disquiet in labour and to some lesser extent the tories.

So I think some of the past week or so's rise is a little bit of a short term sigh of relief that Corbyn has edged back from seemingly on the threshold of power.

In terms of the market and brexit, I think that's a known unknown. The only outcome that I could see now that might cause a substantial drop from here, in my view, is if there is a confirmation referendum leading to the markets hoping for a reversal of brexit, but then resultant vote is a clear choice of 'no deal' - there would really be no option left but for politicians to pull the plug!

I think any other scenario is already priced in.

A clear reversal of brexit in a second referendum might result in a short term drop in the FTSE due to a rise in the pound, but that (a rise in the pound) would be because investment is then re-diverted back to the UK (hence why the value of the pound increases - more demand for pounds!), which would then be a longer term boost for the economy and therefore eventually the market. But short term there might be a blip (reverse of what happened after the 2016 vote).