Stocktake: Just how low can sterling go?

How low can sterling go?

Sterling has plunged by more than 20 US cents since hitting $1.50 on June 23rd. How low can the pound go?

A lot lower, say market strategists. Goldman Sachs believes a "freefall" will be avoided, but expects a "second leg of weakness" that will see sterling hit $1.20 within three months; price targets ranging from $1.15 to $1.20 have been issued by Deutsche Bank, Société Générale, UBS, JPMorgan, and HSBC; and Allianz's Mohamed El-Erian warns sterling could even "head to parity" with the dollar.

Contrarian traders with strong stomachs might be tempted to catch the falling knife, given that speculative bets against sterling are currently at extreme levels.

However, HSBC points out this alone “does not prevent the pound from weakening further”, and history certainly shows that prices can always go lower than one might expect.

In 1992-1993 and in 2008-2009, Bank of New York Mellon noted last week, the pound suffered falls of 29 and 34 per cent respectively. A similar peak-to-trough decline on this occasion would see sterling bottom at $1.13. Sterling is currently at levels last seen in 1985; there were counter-trend rallies during that bear market, but it eventually fell as low as $1.05.

Currency trading is not for the faint of heart at the best of times; if ever there was a time for stop-loss orders, this is it.

Clueless Tory Leadsom downplays Brexit impact

El-Erian's warning of further heavy sterling falls came with a warning that the UK "urgently" needs to "get its political act together". Conservative MPs seem to think otherwise, given that many of them believe that Brexiteer Andrea Leadsom should be the next prime minister.

In a speech last week billed as a major speech on the economy, Leadsom declared it was time to “banish the pessimists”. Already, she said, “we can see that the forecasts of a disaster for sterling, for equities and for interest rates have not been proven correct”.

That's a funny way of looking at it, given that sterling has plunged to 31-year lows; bank share prices have tanked, with Barclays, Lloyds and RBS all losing about a third of their market value; property funds are freezing redemptions; and the Libor-OIS spread, an indicator of banks' willingness to lend to each other, has doubled to its highest level in four years.

Yes, the FTSE 100 is higher; however, Leadsom, who on Monday pulled out of the race for the Conservative leadership, didn’t seem to realise this is merely because it is dominated by multinationals whose non-UK revenues have been artificially swollen by sterling’s collapse.

Leadsom was busy spouting similarly myopic sentiments during the referendum campaign, describing Bank of England governor Mark Carney’s warning of a Brexit-induced recession as an “incredibly dangerous intervention . . . nonsense that is totally unjustifiable, totally speculative stuff”.

According to Boris Johnson, Leadsom "has a better understanding of finance than almost anyone else in parliament".

Investors can only hope that that is not the case.

US stock correlations spike higher in nervy market

US indices have rebounded to pre-Brexit levels and are not far off all-time highs, but investors are less calm than meets the eye.

According to Citigroup, one-month correlations among the S&P 500's 50 biggest companies are near their highest levels since the European sovereign debt crisis in 2011.

High correlations mean stocks are tending to rise and fall in unison rather than being driven by company-specific news.

Correlations invariably spike in nervy markets, but there is a bright side. Firstly, it can lead to occasional bargains, with individual stock declines driven by herd behaviour rather than company-specific news. Secondly, it's historically been a buy signal for markets, says Citigroup's Tobias Levkovich; stocks typically rise over the following six-12 months.

Insiders buy shares after earnings forecast downplayed

The US earnings season begins on Friday and investors can expect the usual pattern of “under-promise and over-deliver”, with companies invariably beating deliberately lowballed estimates. Doing so is good PR, but that’s not the only reason that executives play this old Wall Street game.

A new study has found that managers often don’t pass on positive information relating to their most recent sales. In fact, they tend to issue pessimistic forecasts in such environments, consistently adopting a more downbeat tone during earnings conference calls.

Why? The usual assumption is that management is just being cautious, downplaying investor expectations so that they can be exceeded at a later date. However, it also creates “post-announcement trade opportunities” – that is, they can buy company shares on the cheap if analysts and investors are disappointed by guidance.

A cynical interpretation? Apparently not – the above-mentioned pattern whereby managers actively play down expectations during healthy economic environments is strongly associated with insiders subsequently buying company shares. See http://goo.gl/LJK9tM.