Is it Time to Buy the Pound? - Vivek Kaul's Diary
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Is it Time to Buy the Pound?

Oct 27, 2016


"You have been weighed in the balances and found wanting." According to the Bible that's the message from God to King Belshazzar in ancient times. I reference it because today we're going to talk judgement.

Not the divine kind. But I do want to show you how a machine is now capable of judging the lives of men, and how this week we could see a day of judgement - a reckoning - for the European banking system.

But first, the pound. I was in America last week, which brought home just how extreme the situation is. Life was expensive. For my friends - I found the time to visit some British friends, who work and earn in dollars but still "convert" everything into pounds in their heads - life is great. They feel like they've just had a 20% pay rise. They haven't. But I let them pay for the beers nonetheless.

The common view on the pound now seems to be that this is a political story. No one quite knows what Brexit is going to look like. It is in the EU's interest politically to act strong and talk hard Brexit. Markets are finding it hard to figure out what the "price" of Brexit is going to be and what that means for the pound, which has driven the currency down to historic lows.

But let's analyse that view in the cold light of day. Whenever there's a consensus view in the press like that there's a strong chance it's just a kind of groupthink. And wherever we find extreme situations you can be sure there's opportunity, if you can find it.

I'm no master investor. I don't manage billions in capital. But I'm lucky enough to know lots of people who do. In times like this, I defer to people smarter than me. Like Charlie Morris - investment director of The Fleet Street Letter and a man who managed more than $3bn in the City for nearly two decades.

His view on the pound? It's not politics, it's monetary policy. And it means opportunity.

First off, the context. Charlie believes the long-term fair value of the pound vs the dollar is roughly $1.50. It's now around $1.20 - a 20% fall from its pre-Brexit levels. Can that really be all about politics?

Over to Charlie:

  • People believe the pound is cheap due to politics. Really?

    Turkey had a coup and the lira fell by 7%. Mexico worried about Trump's wall. That saw the peso fall 10%.

To put it another way, the uncertainty over Brexit is roughly three times worse than anarchy and blood in the streets of Turkey. Is that a fair and reasoned judgement? Or is there more to the story? Back to Charlie.

  • The pound is under great pressure now due to QE and Zirp. The playbook for monetary stimulus is currency down, stockmarket up. That's what we've seen happen in Britain.

    Look at the history of QE in Japan and Europe in recent years and the pounds move fits perfectly.

    Euro QE began in late 2014. The euro fell 25% to 1.05 from 1.40 over six months.

    Japan kicked off QE in 2012. The yen fell 40% - 0.0135 to 0.008. Rallied since but is probably back on the way down.

    In my opinion, sterling's fall is commensurate with QE/Zirp late in the game. Not dissimilar to the EU/Japanese experience.

Keep in mind that the Bank of England didn't wait long after the referendum vote to announce more "stimulus". It went big on the money printing before any real economic data could possibly have fed through the system. It just lurched straight for QE and lower rates because that's what it does now. Plan B, C, D and E all involve printing more money too.

The pound's fall is roughly commensurate with what happened to the euro and the yen after QE. It's just been more dramatic. According to Charlie, there are plenty of reasons to be bullish on the pound:

  1. The pound is cheap
  2. QE will end early
  3. Global FX pressure value will shift to eurozone and Japan
  4. Britain has a bright future outside of the EU
  5. Lacklustre capital markets will keep the lid on sterling - any rally will be slow
  6. Short sellers will get bored. They dumped sterling in record size. Now they have to buy it back.

In case you missed it, there's a pretty big prediction in there. The pound will rally and the Bank of England will end its stimulus package early. We'll follow that story right here in Capital & Conflict.

If Charlie is right it wouldn't surprise me. And it'd probably delight readers of The Fleet Street Letter. Charlie shares his insights and investment advice - share and fund recommendations - directly with them each week. You can try it out for a month without committing to any subscription fees, too. Find out more about that here.

Judgement day approaches for European banks

Another huge story this week. Many of the world's largest banks will be reporting their Q3 results.

The news from America has been positive so far. JP Morgan, Wells Fargo, Citigroup and Bank of America Merrill Lynch have each beaten expectations. But you're no doubt aware that America and Europe have trod very different economic paths since the financial crisis.

Europe's biggest lender, Deutsche Bank - which has seen its share price halve in the last 12 months - is expected to make a loss when it announces results on Thursday; analysts' forecasts range from €610 million to €2.1 billion. Given the bank made a €6.8 billion loss in 2015, some (Deutsche employees, mainly) may even be bold enough to suggest the bank is heading in "the right direction". Even if that is true, there's still a heck of a distance to travel... and it may have just got longer.

Deutsche is currently fighting a battle to reduce a suggested fine of $14 billion from the US Department of Justice for mis-selling mortgage-backed securities in the run up to the 2008 crisis. But yesterday, the Financial Times revealed that the bank's next bout of litigation could be just around the corner.

The issue revolves around Deutsche's role as a trust administrator for various institutional investors, who claim that the bank failed in its duty to protect their investments (mortgage-backed securities, again) as they plummeted in the wake of the financial crisis. A document filed in court claims that Deutsche "discovered and knew of widespread errors, breaches and systematic servicing violations triggering events of default under the governing documents for the trusts, but failed to protect the trusts in order to avoid exposing [its] own misconduct".

That fine could end up being billions of dollars. So if you thought it couldn't get any worse for Deutsche's shareholders, you may well have been wrong. Tim Price sees no reason for optimism with Deutsche, or indeed the vast majority of eurozone banks. His new report makes for grim reading, and demonstrates why British savers who think the eurozone's sclerotic economy won't affect them could be in for a nasty shock. Get up to speed here.

British banks are predicted to follow America in exceeding expectations, incidentally. But needless to say, the expected good news hasn't come without the obligatory warning of "storms ahead" - namely, you guessed it... Brexit. But I'm not going to explain what that means for Britain, because I don't know yet - and if anyone does, I'm all ears.

Hanged, drawn and quartered by a machine

Over the weekend news broke that researchers have had success using a machine to predict court judgements. That's a big step forward for AI. Weighing up the moral and ethical nuances of a court case is something that was generally considered beyond a machine - a uniquely human trait.

But these results could prove otherwise. It's not perfect yet. But in 79% of cases studied, the decision made by human judgement of the court and the decision reached by the AI were the same.

Would you want a case you were involved in judged by a machine? It would be emotionless, calculating and completely unbiased. Isn't that what the law should be anyway?

Please note: This article was first published in Capital & Conflict on October 25, 2016.

Nick O'Connor is a writer and editor at Moneyweek. He is also the publisher of Exponential Investor.

Disclaimer: The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.

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