What Brexit Showed us About People’s Understanding of Markets

In the aftermath of the Brexit vote, a lot of remain supporters were very quick to point to the markets for evidence of what a calamity the outcome was going to be.

Surely enough, stories aplenty emerged from the mainstream media with such headlines as “FTSE 100 and Sterling Plummet“, “Sterling Falls and Bank, Airline and Property Shares Tumble” and, perhaps best of all, “More Than £50 Billion Wiped off FTSE 100“.

The charts presented in the BBC article show massive moves with values plummeting as Brexit shocks the economy. But anyone who’s taken aback by these images is clearly unfamiliar with how markets operate.

bbFirstly, these are hourly charts, showing the price action over the course of one week. Conversely, to the right is a weekly chart for the FTSE 100. Brexit is represented by the fifth candle from the right, the red one with large wicks on top and bottom. The relatively small red area indicates the total drop from the start of the week to the end, while the wicks represent the total price movement during the week.

Suddenly, the move doesn’t seem all that significant. The thing is, as many central bank interest rate announcements will show, markets react violently to news all the time. A chart with a sudden drop will be a common sight to any trader. Certainly, the post-Brexit one was particularly large, but that was to be expected. As the chart to the right shows, the FTSE quickly recovered.

This is how markets behave. When major news happens, traders react quickly, either to profit from the move or shield themselves from losses. Price will drive down, or up, and then retrace back somewhat. After a while it’ll carry on with its usual movements and the event will disappear into the background noise.

Furthermore, the idea that £50 billion was somehow ‘wiped off’ the FTSE 100 is even more problematic than this over-hyped reaction to a short-term move. A large amount of the force behind this move is intra-day traders moving their positions around to try and protect their profits and assets. Any investor who sold at the bottom of this move would have been mad. As soon as the main move had passed, bullish traders returned and money quickly began flowing back in. Again, this is just how markets work.

Unlike the FTSE, sterling hasn’t recovered its losses in quite the same way. However the drop in value of the pound is a two-edged sword, as it can drive up import prices and make holidays more expensive, but it also makes exporting more lucrative and offers an incentive for tourists to come to the UK.

The overall point here is that it’s very easy for the media to show people a dramatic graph and exclaim about how Brexit has ruined the economy. The fact that’s been so successful points to a serious lack of understanding about how markets operate.

Part of this is down to the lack of finance and economics in mainstream education, while part of it is also down to the way in which the media presents the information. Most people have next to no understanding of how the finance industry works, and telling them that the FTSE has ‘plummeted’ is as good as saying that the economy is completely wrecked, when in fact all it means is that traders did what they always do and traded a news event.

The longer term economic consequences of Brexit are another discussion, and the markets will react to whatever developments transpire over the coming months and years. The real take-away from this is that market moves need to be seen in a longer-term context. They should be taken simply as traders reacting to news, not news in their own right, and certainly not a sign of major economic calamity.

It would be a much better world if schools taught economics and finance the way they teach citizenship. Perhaps then people would understand markets and their movements, and maybe even get involved, instead of perceiving the industry as an impenetrable world reserved for a privileged few.

Entrepreneurs Will Thrive in Post-Brexit Britain

The aftermath of the EU referendum has seen widespread panic and speculation from nearly every pro-Remain campaigner regarding the future of Britain’s economy. Recently, the German FDP party commissioned a London billboard saying “Dear start-ups, Keep calm and move to Berlin”. The narrative being peddled by popular journalists and mainstream media outlets is that Britain’s departure from the EU is going to be disastrous for the UK’s thriving start-up sector.

Nearly 40% of start-ups worth $1 billion or more are based in the UK, putting us ahead of even the USA’s Silicon Valley in terms of entrepreneurship. But thanks to the collapsed sterling, reduced stocks and losing access to the single market, entrepreneurs will sooner take their business to Europe than deal with current market turmoil. Despite the speculation, however, the facts tell a different story.

Entrepreneurs have always needed to carefully manage the risks involved in their business ventures in order to secure funding. Start-up teams who can develop a good risk management plan will be highly attractive to investors. In this regard, leaving the EU has presented new opportunities for start-ups to get off the ground in that they can appeal to backers who want to stay one step ahead in an increasingly uncertain global market. If a business can confidently demonstrate how to do that, incorporating a four-quadrant risk management framework, investors will want to snap them up.

The need for entrepreneurship is not going away, and the demand for new innovations is not going away. Let’s not forget that some of the most successful businesses in the world were start-ups in times of extreme market uncertainty – Disney (1923), HP (1939) and Microsoft (1975) to name a few. Indexes of entrepreneurship rose during the recession of 2008-09, with over 550,000 start-ups launched. Even the Long Depression of the 1870’s coincided with a rise in registered patents.

Fast-forward to the current year and we’re seeing a similar phenomenon in the aftermath of Britain leaving the EU. Despite pro-Remain campaigners insisting that entrepreneurs will henceforth take their business to Europe, the number of new businesses registered in the UK has actually increased. According to the latest figures from Companies House, 53,000 new companies have registered since May, putting the total number at an all-time high of 3.7 million. That’s one company for every 17 people.

Additionally, a report from the Company Warehouse found that, from 30th June until 4th July, 13.1% of directors forming new companies in the UK were EU nationals, risen from 11.5% recorded in the March-April period. If entrepreneurs were so terrified of the post-Brexit financial climate, why has there been an increase in foreign investment? The authors of the report acknowledged that “[w]e were pretty sure that we would find a dramatic fall in the number of EU citizens starting businesses in the UK […] In fact, we found that the numbers had gone up.”

Leaving the EU has liberated British-based entrepreneurs from coming under a restrictive tax and regulation system. One of the most significant factors driving new business investment is low corporation tax. Naturally, companies want to start up in countries where they can keep most of their profits. Reducing the cost of capital in this way attracts more corporate investment, which corresponds to a boost in GDP.  This is corroborated by reports published by both the HM Treasury and the Office for Budget Responsibility, which found an increase of 0.3-0.5% in investment for each percentage point reduction of tax.

Companies in the UK currently pay a basic rate of 20% corporate tax on their profits. Last week, then-Chancellor George Osborne pledged to slash the rate to 15%, a move that’s been heavily criticized by EU officials in France and Germany, whose corporate tax rates are among the highest in Europe. Ideally, the EU would see a harmonization of tax rates across the board, a move that would greatly damage intra-European competition. They have been consistently critical of low tax countries including Ireland, who have maintained the second lowest corporation tax in the EU at just 12.5%. This is why Ireland is such a good country for start-ups and boasts one of the highest foreign investment rates in the world. Despite this, former French Prime Minister Lionel Jospin believes it is “unfair”.

The EU business ethos is directed toward curbing market dominance rather than fostering entrepreneurship. Not only are these regulations stifling the growth of businesses, they are expensive. It is estimated that EU regulations have cost UK businesses £2.3billion since 2013, according to a report by the Regulatory Policy Committee.

Too much focus has been put on the hypothesized drawbacks of market uncertainty, and not enough on the opportunities emerging from the change. Smart entrepreneurs know this and are identifying new strategies than would not have been possible before June (for example, taking advantage of the weak pound to increase their exports). By eliminating the prospect of further EU interference in the UK tax and regulation system, the UK outside the EU appears more attractive to entrepreneurs, not less. Indeed, the evidence is already showing this.

Traders Await Interest Rate Announcement

On Thursday 14 July the Bank of England will make its monthly interest rate decision. Normally a rate increase leads to the Pound gaining value against other currencies, as well as leading interest rates on consumer loans and bonds to rise in turn. A cut will typically have the opposite effect.

However, the post-Brexit situation is rather more complicated. Markets are concerned about instability in the British economy following the decision to leave, and any move by the BoE to stabilise the situation could lead to improved confidence.

The BoE is currently expected by many to cut rates by 25 basis points, from the present 0.5% to 0.25%. To get an idea of the effect an announcement like that can have on markets, one only needs to look at the previous day’s announcement from Canada.

USDCAD
The USD/CAD forex pair during Wednesday 13 July. The large red candle shows the US Dollar dropping against the Canadian Dollar as the CAD gains value after the announcement.

There, a decision to keep the interest rate at 0.5% lead to the Canadian Dollar gaining over 100 pips against the US Dollar (see picture). That move largely happened within the two minutes following the announcement before the market hit support.

Announcements like these have an impact on a wide range of markets and asset classes, most obviously the national stock indices like the FTSE100 in the UK. However the foreign exchange or ‘forex’ markets often provide the best chance for short-term intraday traders to catch the fallout from these events.

Using the Canadian example, a trader taking a short position on the USD/CAD pair with a £10/pip lot size would have stood to profit £1,000 had they succeeded in catching the entire move.

A large lot size like that is obviously risky, which is why using a stop loss is always important. Likewise, some traders will fear a sudden reversal of the move and take their profits well before the whole move has occurred.

However it is possible for traders to catch a move like this without having to anticipate the direction of the result ahead of time. Using orders placed either side of the price in the last few minutes before the announcement, known as bracketing, traders can stand a chance of profiting from the move whichever way it goes. It is of course important to cancel the other order once one is triggered.

Like any strategy, there is no guarantee of success. An order placed too close to the current price risks being stopped out by general volatility, while one too wide might not be triggered and miss the move, depending on the impact the news has. Sometimes the move will reverse midway and stop traders out unexpectedly. Leveraged spread betting is always going to be a risky activity.

That said, the Canadian example shows that these moves do occur, and the Bank of England announcement could well be a much more substantial piece of news.

Every trader has their own style and their own preferred strategy, and this is just one example of how profits can be gained from news like this. The most important thing is that traders shouldn’t risk more money than they can afford to lose.

Fundamental announcements like this happen all the time in trading, but one of this potential size is not to be missed. The post-Brexit environment creates uncertainty about how the market will react to this news either way, and a normally discouraging interest rate cut could be taken as a stabilising move that restores some confidence in the Pound and the British economy. It is a very volatile, very high-risk time to be in the markets, but that is often when the best opportunities emerge.

This article does not constitute investment advice. Please see our full disclaimer.

The Euro is Deepening the Depression in Southern Europe

Currency union used to be very fashionable. There was a time when the Euro was the future – it led to increased growth, lower unemployment, and greater prosperity. Opposing it – and opposing the Exchange Rate Mechanism that was intended as its precursor – could only derive from some atavistic nationalism. How times have changed.

The ERM crashed the British Economy in 1992 and the Eurozone is not prospering today, instead it is going through a deep economic depression. This can be seen most clearly in Southern Europe – by which I mean Greece, Spain, Portugal, and Italy – where youth unemployment ranges from 25 to 50%, economic growth is either near non-existent or negative and political instability is growing. The Euro did not merely fail to prevent this crisis: it actively helped to cause it, and it is making it worse.

While times were good, participation in the Euro allowed nations with weaker economies – like those of Southern Europe – to borrow at low interest rates that reflected trust in the ECB, not in the national governments it represented. This allowed them to pursue wasteful policies, to cripplingly restrict their labour markets and make themselves less competitive, all without having to borrow at higher rates like other countries would.

On top of this the EU did not enforce the laws intended to keep Eurozone countries solvent, enabling economic mismanagement. The international bond markets did not punish economic mismanagement as they would with normal countries – these nations were allowed to become more and more uncompetitive until the financial crisis brought the house of cards crashing down.

All of that cannot be undone, only recovered from, but the Euro makes such recovery far harder. As the Euro is a very strong currency – thanks in the main to the economic success of Germany – it crushes the export markets of weaker economies, while the benefits to imports that a strong currency brings aren’t much use to countries in economic free-fall. The USA began its recovery when Roosevelt devalued the dollar. Argentina dug its way out of its depression in the 90s by unpegging from the dollar and allowing its currency to devalue. Greece, Portugal, Spain, Italy and France cannot devalue their currencies because they are in the monetary straitjacket of the Euro.

Any reasonable attempt to help those economies would have at least allowed them to unpeg from the euro until they returned to economic health, as even Wolfgang Schäuble once suggested. That though, would be a blow to federalism, which ensures that the dogmatically federalist EU will not be reasonable.

This is not to say that structural reforms aren’t needed. They are, and they are being slowly made, but without devaluation to kick-start a recovery it could be decades before Southern Europe returns to economic health. That time will see millions of vibrant young people across Southern Europe unemployed and becoming unemployable, birthing a veritable lost generation.  It will mean more bailout dramas, brinkmanship and radicalism. It will mean poverty, desperation and resentment. Southern Europe is on its knees, and the Euro is throttling it.

The only hope for a more pragmatic policy in Brussels is the foreclosure of the federalist dream. We in Britain have a chance to bring about just that. We have a chance to make Brussels rethink its dogmatic federalism – to be reasonable and to give South Europe the monetary flexibility it desperately needs. That chance comes on June 23rd.