Tag: UK

Post-Brexit: Uncertainty Everywhere, Everything on the Sidelines (Cash Too), and Market Index Copycats

Yes, I know markets have been rallying and S&P 500 has been hitting all-time highs. But, remember Brexit?

In case you forgot, the people of United Kingdom voted to leave European Union on June 23rd. Markets then destroyed more than $3 trillion in paper wealth in the next 2 days (Friday and Monday).

After that, market just shook it off. As Taylor Swift says, “Shake It Off.” “It’s gonna be alright.”

The actual businesses and people in the UK just cannot shake, shake, shake, shake, shake,….it off.

The UK job market went into “freefall” as the number of people appointed to full-time roles plunged for a second successive month in July, according to a survey. An index of permanent positions dropped to 45.4 from 49.3 the previous month, the lowest level since May 2009. A number below 50 indicates a decline in placements (contraction). Employers in the survey cited Brexit-related uncertainty.

The same uncertainty that scared away some investors and sit on cash, including me. 91% of investors made money in July as US markets kept hitting record highs, according to Openfolio, an app that allows you to connect and compare your portfolio to 60,000 other investors. Average cash holdings of these investors grew 25% over the past three months leading up to July.

75% of investors lost money in June as Brexit uncertainly weighted in. The portfolio of the majority of investors are tracked with S&P 500. The problem here can be described by Ron Chernow,

As a bull market continues, almost anything you buy goes up. It makes you feel that investing in stocks is a very easy and safe and that you’re a financial genius.

93% of investors lost money in January as the energy prices plunged and uncertainty in China scared investors.

Here’s another quote by Robert Kiyosaki (Rich Dad),

As a bull market turns into a bear market, the new pros turn into optimists, hoping and praying the bear market will become a bull and save them. But as the market remains bearish, the optimists become pessimists, quit the profession, and return to their day jobs. This is when the real professional investors re-enter the market.

I’m naturally contrarian like Bill Ackman. I love going against the crowd. I love Bill Ackman. When I met him, I had no problem keeping my cool after learning my lesson from the Ben Bernanke experience.

Bill Ackman (left) Khojinur Usmonov (right)
Bill Ackman (left)
Khojinur Usmonov (right)

Being contrarian has made me money. It has also got me into “value trap” like buying $TWTR around $34.

The UK labor market survey was released a day after Bank of England cut rates and expanded quantitative easing.

  • On Thursday (August 4th), Bank of England (BoE) cut rates by 25bps (0.25%) to 0.25%, the lowest since the central bank was founded in 1694 (322 years) and the first cut since March 2009.
    • The central bank signaled further cut to the interest rate if the economy deteriorates further, “If the incoming data prove broadly consistent with the August Inflation Report forecast, a majority of members expect to support a further cut in Bank Rate to its effective lower bound at one of the MPC’s forthcoming meetings during the course of the year.” (I’ll address the recent economic reports and BoE’s forecasts later in this article)
    • During the press conference, Mark Carney (The Governor of BoE), stated he is not a fan of negative interest rates. He clearly stated that MPC (Monetary Policy Committee) is very clear lower bound is above zero. Options other than NIRP (Negative Interest Rate Policy) are available, “we have other options to provide stimulus if more stimulus were needed.”
    • Carney told banks they have “no excuse” not to pass on the rate cut in full to customers. In other words, he’s telling them not to mess with him.
    • “With businesses and households, anyone watching, if you have a viable business idea, if you qualify for a mortgage, you should be able to get access to credit.”
  • With 6-3 vote, they will provide an extra 60 billion pounds ($78 billion) of newly created money by buying government bonds over six months, extending the existing quantitative easing (QE) to 435 billion ($569 billion).
  • To cushion the blow to banks’ profitability, BoE will provide up to 100 billion pounds ($130 billion) of loans to banks close the base rate of 0.25% under the Term Funding Scheme (TFS). The scheme will charge a penalty rate if banks do not lend.
    • “The TFS is a monetary policy instrument. It reinforces the transmission of Bank Rate cuts and reduces the effective lower bound toward zero, it charges a penalty rate if banks reduce net lending, it covers all types of lending, and it is funded by central bank reserves.” (Page 6)
  • With 8-1 vote, BoE will also buy as much as 10 billion pounds ($13 billion) of corporate bonds in the next 18 months, starting in September. For that, BoE is targeting non-financial investment-grade corporate bonds, issued by “firms making a material contribution to the UK economy” (Page 3)

I did not expect that much of stimulus.

While I was wrong on this one, I was right in July when markets expected rate-cut and expansion of QE.

Note: I’m always active on Twitter. Follow me, @Khojinur30.

The stimulus comes as recent economic data has been weak. Confidence tumbled. Manufacturing, construction activity, and service-sector all shrank sharply.

Consumer confidence dropped 11 points to -12 in July, the sharpest month-to-month drop (M/M) since March 1990.

GfK Consumer Confidence Index Souce: Trading Economics
GfK Consumer Confidence Index
Souce: Trading Economics

Activity among UK manufacturers contracted at its fastest pace at the start of third quarter. UK manufacturing PMI (Purchasing Mangers’ Index) fell to 48.2 in July, down from 52.4 in June, the lowest levels since February 2013.

Market/CIPS UK Manufacturing PMI Source: Markit/CIPS
Market/CIPS UK Manufacturing PMI
Source: Markit/CIPS

Manufacturing sector accounts for 11% of the UK economy.

UK manufacturing stats:

  • Employs 2.6 million workers, accounting for 8.20% of the working population.
    • “UK manufacturing employment decreased for the seventh straight month in July, the rate of job loss was the second-sharpest for almost three-and-a-half years” the PMI report said.
    • It also stated “Weaker inflows of new work and declining volumes of outstanding business also suggest that employment may fall further in coming months.”
  • Contributes to 10% of GVA (Gross Value Added), which measures how much money is generated through goods and services produced. In 2014, GVA per head on average in the UK was 24,616 pounds ($32,113), growing 3.6% Y/Y.
  • Accounts for 44% of total exports. Exports alone account for 27.4% of the UK’s GDP (Gross Domestic Product).
    • Export orders rose for the second successive month in response to the weaker pound. On July 6th, sterling plunged to $1.2788, the lowest since 1985.
  • Represents 69% of business research and development (R&D), which accounts for mini 1.67% of the UK’s GDP.

What is also interesting in the PMI report is the input price. Input price inflation rose to a five-year high in July, “reflecting a sterling-induced rise import costs.” Some part of the increase in costs “was passed through to clients.”

Markit/CIPS UK Input Prices Index Source: Markit/CIPS
Markit/CIPS UK Input Prices Index
Source: Markit/CIPS

UK construction industry, accounting for 6.5% (Parliament.uk – PDF download) of the economic output, suffered its sharpest downturn since June 2009 as the sector came under pressure from the uncertainty. UK construction PMI inched down 0.1 to 45.9 last month.

Markit/CIPS UK Construction PMI Source: Markit/CIPS
Markit/CIPS UK Construction PMI
Source: Markit/CIPS

Clients of the construction firms had adopted “wait-and-see” approach to projects rather than curtailing and canceling the projects.  The same “wait-and-see” that has caused investors like me to sit on cash (Cash on sidelines).

“Insufficient new work to replace completed projects resulted in a decline in employment numbers for the first time since May 2013” the PMI report stated. The construction industry accounts for 2.1 million jobs, 6.62% of the working population. The industry contributes to 6.5% of GVA.

And services too. UK services PMI plunged to 47.4 in July from 52.3 in June, the first contraction since December 2012 and the fastest rate of decline since March 2009 and the steepest M/M decline (-4.9) since PMIs began in July 1996.

The sector accounts for 78.4% of the UK economic output.

Markit/CIPS UK Services PMI Source: Markit/CIPS
Markit/CIPS UK Services PMI
Source: Markit/CIPS

Not surprisingly, the sentiment of businesses dropped to the lowest since February 2009.

Market/CIPS UK Services PMI Expectations Source: Markit/CIPS
Markit/CIPS UK Services PMI Expectations
Source: Markit/CIPS

Bank of England slashed its growth and increased its inflation forecasts. The central bank slashed its growth forecast for 2017 to 0.8% from initial estimate of 2.3%, making it the biggest downgrade in growth from one inflation report to the next. They now expect inflation to hit 1.9% in 2017, from previous estimate of 1.5%.

For 2018, the economy is expected to grow at 1.8% from previous estimate of 2.3%, and CPI is expected to hit 2.4% from previous estimate of 2.1.

Unemployment is expected to reach 5.4% next year from initial estimate of 4.9%, that is more than 250,000 people losing their job….even after the stimulus.

The bank’s outlook also includes lower income and housing prices to decline a “little” over the next year.

UK house prices fell 1% in July, according to a survey by Halifax, Britain’s biggest mortgage lender. The reports for the next few months will sure be interesting.

Confidence will continue to fall in the coming months as uncertainty will continue to exist and businesses will be extremely cautious with regard to spending, investment and hiring decisions, and people will be cautious with regard to spending.

All these survey conducted shortly after Brexit reflects an initial reaction. What matters now, especially after the new wave of stimulus, is the level of uncertainty and the magnitude of contractions. The three PMIs – manufacturing, construction, and services – accounting for almost 96% of the economic output, does not cover the whole economy as the retail, government and energy sectors (Oh energy), are excluded. However, it is clear the UK economy is slowing and is likely to slow in the coming quarters. Until clouds stop blocking the sun from shining, we won’t have a clear picture of the economy.

Will there be a recession or not? I’m not calling for any recession at the time. I will get a better idea of where the UK economy is heading as we get more data.

Tomorrow (Tuesday):

Manufacturing production.

In two weeks:

Consumer Price Index (CPI) – With data reflected in the PMIs and the amount of stimulus announced by BoE, inflation overshoot is possible. This report in two weeks will only reflect July. We should get better of where inflation is going in September and October.

Jobs report

Retail Sales

In four weeks:

Another manufacturing and construction PMIs. The services PMI comes the week later.

I should make a call on whatever the will be recession after the data and some by mid-September.

Without fiscal stimulus, monetary stimulus alone cannot offset most of the Brexit ills. Philip Hammond, the chancellor, signaled loosening of fiscal policy in October. By then, it just might be too late.

Extra: Bad Karma

FinTech To Halt Or Grow After Brexit?

Silicon Valley is the fintech capital of the world. London is the fintech capital of Europe. After the Brexit vote, the rise of fintech in UK might be under a threat.

Total venture capital investment in technology for UK increased to over $3.6 billion in 2015, 71.43% increase from 2014. Of that, London-based tech start-ups accounted for 62.55%

Total VC Tech Investment Amounts UK/London 2010-2015
Total VC Tech Investment Amounts UK/London 2010-2015

In the last 5 years, UK technology companies have collectively raised $9.7 billion, with London-based companies accounting for 54.52% of it or $5.3 billion.

Since 2010, investment in the British firms soared over 12-fold, while investment in the London-based firms soared over 53-fold.

Brexit can halt the growth of UK fintech industry.

Why is that? UK could lose its “passport.”

Many companies in EU, including fintech, use mechanism known as “passporting” to access Europe (European Economic Area) by getting licensed in a EU nation and be able to sell their products/services across the bloc. If the passporting privilege is lost, companies will have to submit application in every single country it wishes to operate in, which is time consuming and cost prohibitive.

Not only fintech companies, but also international banks would have to find a new legal home base. Large U.S. banks, such as Goldman Sachs (GS), Citi (C), and JP Morgan (JPM), employing thousands of people, would have to move its operations to other cities, such as Paris or Frankfurt.

Fintech companies could take the same direction as the banks. It is possible they will move to Ireland (Dublin). Ireland is European home (EU base) to Apple (AAPL), Google (GOOGL, GOOG), Microsoft (MSFT), Dell, Twitter (TWTR), Airbnb, and more. The corporate tax rate, which is one of the most important part of Irish investment attraction, is 12.5%, one of the lowest in Europe. That’s very low compared to United Kingdom’s 20% rate and Europe average of 20.24%.

One other important part of Irish investment attraction is its KDB (Knowledge Development Box). Certain intellectual propriety income, such as patent/copyright, are subject to just 6.25% tax, half of its famous 12.5% corporate tax rate. Not only that, but there is also 25% tax credit for research and development spending.

The KDB is clearly aimed at incentivizing innovate R&D. It provides 50% deduction in tax rate from qualifying profits. In other words, 50% allowance. No wonder so many U.S. tech companies are using Ireland as their European base.

In Europe, overall fintech investment increased 120% between 2014 and 2015. The number of deals increased by 51%. Both should continue to increase as states like Ireland continue to attract start-ups and talent. However, if UK files for Article 50 and other EU members plans to follow the same path, it is very possible the increased uncertainty over the EU cartel will scare away start-ups and international investors.

There’s also the issue of free movement of labor. One in three UK start-up workers are outsiders. Of the 34% workers from outside the UK, 20.7% are from the EU. 66% hold UK passport. The most common non-UK nationalities were Irish, American, and Spanish.

Brexit is likely to make it costlier and complicated for start-ups to attract and retain talent. Will the UK allow the free movement of labor? I don’t think so. One-third of leave voters stated the main reason for wanting to leave the EU “offered the best chance for the UK to regain control over immigration and its own borders.” Plus, other EU members, such as Ireland, probably want start-ups and talents to come to their cities, not stay in the UK.

In 2014, financial and related services employed nearly 2.2 million people, 7% of the UK workforce. The industry contributed 11.8% of UK economic output in 2014. London, the financial center of the UK and the world, accounted for 714,000 of the employment.

The British fintech firms employ about 61,000 people (2015 data), 2.8% of the financial and related services employment and 5.7% of financial services employment (both of which 2014 data).

The stakes are definitely high here.

Peer-to-peer (P2P), money-transfer and payments start-ups would be hardest hit by Brexit and by the end of EU passporting.

In April 2015, London-based P2P lending company, Funding Circle secured the largest single deal of the year with a $150 million funding, valuing the startup at over $1 billion, going straight into the “unicorn” club, private companies valued at $1 billion or more. The company is online marketplace that allows investors to lend money to small and medium-sized businesses.

European Investment Bank (EIB) recently announced it would the platform to make 100 million pounds ($133.3 million) loans to UK firms. 20% of UK’s fintech firms focus on credit and lending, which P2P falls under. UK has 74.3% share of the whole EU alternative finance market, which particularly includes online alternative finance, from equity-based crowdfunding to P2P business lending and more.

In 2014, UK P2P business lending market size was 998 million euros ($1.1 trillion), 42.70% of total UK alternative finance market size. As I said above, “The stakes are definitely high here.”

Brexit could reduce lending, especially to 5.4 million small businesses in the UK accounting for 99.3% of all private sector business. Collectively small businesses account for 50% of GDP (Gross Domestic Product) and 60% of employment.

Many of these businesses will encounter financial problems, leading to layoffs of employees and so on (domino effect).

In addition to above, money-transfer and payments start-ups could also be hit hard as they will lose their “passporting” privilege. 54% of UK fintech firms focus on banking and payments. To sum up what I said about “passporting” above, if you’re regulated in UK, you’re regulated across the EU.

Other EU members, such as Ireland, will try to use Brexit to their advantage. They will try to make its laws more attractive to entice fintech firms away from London.

There is also chance the UK will get to keep its fintech firms, only if it differentiates itself with streamlined regulation, tax breaks, and increased support for innovation.

The UK will have to renegotiate the financial regulation with the EU. But I don’t believe they will get what they want. EU is already playing hard-ball. UK has more to lose than the EU.

Article 50 won’t likely be triggered until late this year or early next year. If by then, anti-Brexit campaign gains momentum and the presence of pro-remain politicians increase in the UK government, it is likely UK will not leave EU.

Feel free to read my previous article, Pros and Cons of Brexit.

If you have any views, I would love to know in the comments below. If you have any questions about any issues related to Brexit, I would be happy to answer them ASAP. Don’t be surprised if the answer is 5 paragraphs long. Thank you.

Recap: Europe, Australia, United Kingdom, Canada, and The United States.

This week was full of financial news. I will be talking about some of them, which I consider too important to pass up. I will also give my views on them.

Europe:

Last Monday (March 2, 2015), a report showed that Consumer Price Index (CPI) Flash Estimate ticked up to -0.3% year-over-year from previous -0.6%. Markets were expecting -0.4. The data was little positive. However, It remained in negative territory for the third consecutive month. There are deflation in euro zone. The deflation might soon end later in the mid-year, as Quantitative Easing (QE) program starts this Monday (March 9, 2015).

Last Thursday (March 5, 2015), European Central Bank (ECB) kept the interest rates unchanged. During the press conference, the President of ECB, Draghi stated that the QE would start on March 9. ECB raised its projections for the euro area, “which foresee annual real GDP increasing by 1.5% in 2015, 1.9% in 2016 and 2.1% in 2017.” Remember that these are just projections and can change anytime. Plus, central banks are not right all the time. Mr. Draghi felt confident as he talked about the future of Euro zone. He believes Euro zone will greatly benefit from QE program and some areas already have since the announcement of QE last January.

This week, EUR/USD fell all the way to 1.0838, lowest level since September 2003, due to positive U.S jobs reports, Greece worries and QE program starting next week. I was already short on EUR/USD and I still believe it has a room to go further down.

EUR/USD Hourly
EUR/USD – Hourly

Australia: 

Last Monday (March 2, 2015), Reserve Bank of Australia (RBA) announced that they will leave the interest rate unchanged at 2.25%. In February meeting, RBA cut by 0.25%. This time, they did not. RBA is in “wait and see” mode, for now. I believe another rate cut is coming in the two meetings, depending on future economic reports. In the Monetary Policy Decision statement by RBA Governor, Glenn Stevens stated that the Australian dollar “remains above most estimates of its fundamental value…A lower exchange rate is likely to be needed to achieve balanced growth in the economy…Further easing of policy may be appropriate…”.  I believe RBA is open to further cuts and it will come in the next two meetings. However, positive economic reports might change that direction. As economics reports come out from Australia, we will have better sense of what RBA might do.

Last Monday (March 2, 2015), Building Approvals report came out and it was very positive. It was expected at -1.8%. It came out at whooping 7.9% up 10.7% from previous -2.8%. It shows that more buildings are being built. Thus, creating jobs. However, Building Approvals reports show that building approvals tend to jump around every month. If the report continues to be positive, it might convince RBA to keep the rate unchanged.

Last Tuesday (March 3, 2015), Gross Domestic Product (GDP) came at 0.5%, up only 0.1% from previous report (0.4%). It came out little bit weak from what was expected, 0.7%. It’s still very weak and it might have larger impact on RBA’s future actions. I believe RBA will cut because GDP is not improving much.

Last Wednesday (March 4, 2015), Retail Sales and Trade Balance reports came out from Australia. Retail sales came out at 0.4% as expected from previous 0.2%.  Trade balance on goods and services were a deficit of $980 million, an increase of $480 million from December 2014 ($500 million). All these numbers are in seasonally adjusted term. I believe the gap in Trade Balance from the last two reports might convince RBA little bit to cut the rate again.

I would be short on AUD. I believe it has the potential to go further down to 0.7500. The best pair would be to short AUD/USD (Positive U.S news and upcoming rate hike).

AUD/USD Hourly
AUD/USD – Hourly

United Kingdom: 

Last Thursday, Bank of England (BoE) kept the interest rate unchanged at 0.50% and Quantitative Easing (QE) programme at £375bn. In March 2009, the BoE’s Monetary Policy Committee (MPC) unanimously voted to cut the interest rate to 0.50% from 1.00% (-.50%). The interest rate still stays unchanged and QE stays steady, for now. If future economic reports such as wages, and inflation declines or comes out negative, rate cut might come. If it does not, rate hike might come sooner than expected. I believe it will get better and MPC will decide to raise the rate, sending Pound (GBP) higher.

This week, Pound (GBP) fell after rising last week, due to little negative news from UK and that BoE rejected higher rate for some time being because of concerns in oil prices and inflation. I would not trade GBP at this time. If I’m going to trade GBP, I would analyze its chart first. Did you notice that last week GBP/USD had-daily bearish engulfing pattern and this week there is-weekly bearish engulfing pattern?

GBP/USD - Daily
GBP/USD – Daily
GBP/USD - Weekly
GBP/USD – Weekly

Canada:

Last Tuesday (March 3, 2015), Canadian Gross Domestic Product (GDP) came out little positive at 0.3% from previous -0.2% on monthly basis. It was expected at 0.2%. On quarterly basis, it came out at 0.6% following 0.8% in third quarter.

Last Wednesday (March 4, 2015), Bank of Canada (BoC) left the interest rate unchanged at 0.75% following 0.25% cut last month. Ever since BoC cut the rate last month due to falling oil prices; oil prices has risen and been in $50 range. If oil price continue to fall, I believe they will cut the rate again. There is strong relationship between Canada and oil. As oil gets weaker, Loonie (CAD) gets weaker. Why? Canada is ranked 3rd globally in proved oil reserves. When making a trade decision on CAD, I would look at the oil prices. Of course, I would also look at news and technical. For example, if I want to trade USD/CAD, I would look at both U.S and Canada economic news (rate hike/cut, employment, etc) and technical on chart. If U.S economic news are strong, Canada economic news are weak and USD/CAD is just above strong support line, I would definitely go long on it. However, let’s say if USD/CAD is just below strong resistance line, I would wait for confirmation of a breakout and if the news are in my favor, I would go long.

Last Friday (March 6, 2015), Building Permits and Trade Balance reports were strongly negative. Building Permits came out at -12.9%, following 6.1% the previous month, expected of -4.2%. Trade balance on goods and services were a deficit of -2.5 billion, following -1.2 billion the previous month, expected of -0.9 billion. Both reports were negative, which sent CAD lower. At the same time, U.S non-farm payrolls came out strong, which sent USD higher. As a result, USD/CAD skyrocketed. The reports will definitely be on BoC committee’s mind. As of right now, I would be short on USD/CAD.

This week, USD/CAD was mixed as BoC kept the interest rate unchanged, after cutting it last month (negative for USD/CAD) and strong U.S jobs report (positive for USD/CAD). I would be short on it as I said in the last paragraph.

USD/CAD - Hourly
USD/CAD – Hourly

United States:

Last Friday (March 6, 2015), U.S jobs report came out very strong except the wages. Employment increased by 295,000 (Expected: 240k) and unemployment rate went down 0.2% to 5.5% (Expected: 5.6%). However, average hourly earning fell 0.1%, following 0.5% the previous month (Expected: 0.2%). But, that hourly wages part of the report did not stop U.S Dollar from rising. It was very positive for the U.S dollar because there is little higher chance of rate hike coming in the mid-year.

Since U.S economic news tends to have impact on global markets, here’s what happened; U.S Dollar rose, U.S stock fell, European stock rose, Euro dived, Gold prices fell and Treasury Yield jumped. EUR/USD fell to 1.0838, lowest level since September 2003. USD/JPY rose to 121.28, a two-month high.

So why did U.S stocks sold off? It sold off because of upcoming rate hike, which can be negative for equities, specifically for dividend stocks. As economy is getting better, it should help boost corporate profits. At the same time, strong dollar can hurt them. Rate hike can only make dollar even stronger.

In two weeks, the Fed will be meeting and I believe they might drop the “patient” in its March policy statement.

I would be long USD. The best pairs would be to short EUR/USD (Euro zone delfation, Greece crisis and QE program) and short NZD/USD (RBNZ keeps saying that NZD is too high and they will meeting next week, rate cut?) as I’m already short NZD/USD, and long USD/JPY (Upcoming U.S rate hike and extra stimulus BoJ might announce).

Dow Jones Industrial (DJI) - Hourly
Dow Jones Industrial (DJI) – Hourly
Nasdaq - Hourly
Nasdaq – Hourly
Standard & Poor 500 (S&P 500) - Hourly
Standard & Poor 500 (S&P 500) – Hourly
USD/JPY - Hourly
USD/JPY – Hourly
NZD/USD - Daily
NZD/USD – Daily

Follow my twitter account @Khojinur30 or just click twitter icon on the top right to be directed to my twitter account, for my views that are posted any time. Thank you.