By Guy Ellison, Head of UK Equities Research at Investec Wealth & Investment
A pertinent title for this week’s Weekly Digest, an expression which today simply means a surprise or unexpected event, but which was originally coined for the bookmakers receiving a shock.
A prime example of that was the UK electorate’s decision on Thursday to leave the European Union (EU), going against the momentum of the polls, the markets and implication of the bookmakers’ odds (which had moved from a c.60% chance of Remain in the week before the poll to c.80% on the eve). I have to confess to a certain schadenfreude as your guest author this week; just as your regular correspondent Mr Wyn-Evans enjoys a well-earned break, hoping to have written his last Brexit-themed Digest, he will return to be faced with many weeks’/months’/years’ worth of material as the actual ramifications of the decision play out.
Before we examine the implications, a reminder of the immediate market reaction to the decision: UK Equities were 3.8% lower on Friday, a remarkably measured reaction under the circumstances, especially when compared to the German DAX (off 7%), French CAC (off 8%) and indices in peripheral Europe (off c.12%). Why? As one colleague neatly put it, the UK now has relative certainty, inasmuch we have fired the starting gun on the exit process, whilst there is now a bigger cloud of uncertainty hanging over the Eurozone. The pound weakened by c.10% from its intraday highs of $1.50 and government bond prices gained sharply as investors rushed for safety.
Within the UK’s equity performance, the FTSE 100, home of the UK’s largest companies, fell 3.1% whilst the FTSE 250 fell 7.2%, the latter being more exposed to a domestic UK economy which looks set for some volatility ahead. The abrupt fall amongst the larger market cap names masks the fact that more than 1 in 4 of the FTSE 100 constituents were up on the day (27 to be precise), mostly defensive names which generate a significant proportion of their revenues overseas – just the kind of businesses that we fundamentally like. Sterling, having crested $1.50 on Thursday swiftly moved to a multi-decade low of $1.36 and was weaker against all major trading partners, meaning that a UK company which was down 5% in pounds and pence was nearly 15% cheaper to investors with dollars to spend; cue some bargain hunting by overseas investors. It would be encouraging, though bold on the behalf of the buyer, if this bargain hunting translated into full-blown mergers and acquisitions (M&A).
And so, what next? From a practical portfolio perspective, having taken steps in the run up to the referendum to increase ‘insurance’ within our asset allocation, we would love to be lining up a list of ‘babies thrown out with the bathwater’ to go out and buy. Frustratingly, the market has proved a pretty fair discriminator of where the risks and safe havens lie, the latter having held up well whilst we will probably let the dust settle before sifting through the basket of companies with an “at least 10% off” sale sticker on them.
From a UK policy perspective, the honest answer is that we’re not really sure. Before we even decide when to implement Article 50 and begin the process of leaving the EU, we have to decide who actually is going to make that decision. We have a political vacuum at the top of the Conservative party, and look likely to have one at the top of the Labour party given the weekend’s swathe of resignations. We have economic uncertainty, including: i) How much will domestic consumer and corporate spending slow?
Will inward investment grind to a halt? What will this do for Gross Domestic Product (GDP) growth? Will the Bank of England (BoE) ease rates further to stimulate? ii) Conflictingly, inflation would be expected to rise following the pound’s weakness, so does the BoE increase rates to ward this off and support sterling, but then risk undermining the housing market?
Amidst all this uncertainty we can take some comfort; we have an investment process which is dynamic, which had already taken steps this year to de-risk asset allocation and will meet this week to reassess the lie of the land. Within our preferred equities we have a focus on quality, which comes to the fore in such periods of uncertainty. Finally, the weakness in the pound has meant that for a sterling investor, the impact on portfolios has been significantly moderated by the increase in value of non-sterling assets.
Graph of the week: Brexit in pictures
It’s been a hectic few days in financial markets, with the madness of Friday (24 June) and Monday (27 June) followed by a day of relative calm as key asset prices staged a recovery on hopes that central banks will act decisively to minimise the fallout.
Will it last? With so much uncertainty about the next steps for the UK, one should not rule out further volatility.
In this brief note we look at some of the more striking price moves of the last few days. Our first shows the performance of the British pound and how it plunged to 1985 levels against the US dollar on Friday and Monday, while gold showed its safe haven attractions with a sharp rise.
Our second shows UK 10 year yields. Interestingly, UK yields fell by the most over two days since 2009, reflecting the internal flight to safety and expectations that the Bank of England will cut rates in response to the Brexit vote and the likely recession that should now follow. At one stage UK 10 year gilts were trading at 0.93%.
It was a different story for Italian bonds, however. As our next chart shows, the spread over German Bunds widened shot up on the Brexit news. Italy is seen by many economists as one of the likelier candidates to come under pressure from its electorate to exit the European Union. Italy hosts a constitutional referendum in October that are designed to pave the way for key structural reforms. However anti-establishment parties could scupper these plans and increase calls for a referendum on EU membership. While most commentators still see an “Italeave” as unlikely the risks are still there.
Graph of the week: Brexit in pictures – part 2
With the rally in markets going into its third day (30 June) after two days of heavy selling on the news of the Brexit vote, it’s a good opportunity to run the rule over some of the moves in different markets.
First, we look at the CBOE Volatility Index, or VIX, often regarded as the “fear” index for the way it gauges market moods. High numbers reveal market anxiety, while low numbers show calm. The shock of UK voters opting to leave the European Union (EU) certainly caused a major spike in the index, before coming back as markets rallied. What’s interesting to note however is that the spike in the VIX is a little below levels seen during the market sell-off in January this year. And it is significantly lower than the levels it hit in August last year, when the Chinese yuan devaluation spooked markets and sent the VIX soaring.
The implication then is that central bank assurances and the hope that the UK and EU will act sensibly in their negotiations are doing enough to restore normality to markets. However markets have got it wrong before – as we saw in the build-up to the UK referendum.
The next chart shows the British pound, the clear loser in the turmoil of the referendum result, against the euro. While it has stabilised, it is still significantly weaker than it was beforehand. A weak pound offers some benefits for the UK as it faces a likely recession next year. Exports should become more competitive, especially to the rest of the EU, its main trading partner.
This perhaps explains why UK shares have managed to pretty much recover their losses over the last two days, as our next chart shows. Both the FTSE 100 and the broader FTSE 350 have bounced back and are not terribly far off their highs of the year so far.
Published in the DailyView of 30 June 2016. All prices correct as at the close on 29 June
How has the online trading landscape changed in 2020?
By Dáire Ferguson, CEO, AvaTrade
This year has been all about change following the outbreak of coronavirus and the subsequent global economic downturn which has impacted nearly every aspect of personal and business life. The online trading world has been no exception to this change as volatility in the financial markets has soared.
Although the global markets have been on a rollercoaster for some time with various geopolitical tensions, the market swings that we have witnessed since March have undoubtedly been unlike anything seen before. While these are indeed challenging times, for the online trading community, the increased volatility has proven tempting for those looking to profit handsomely.
However, with the opportunity to make greater profits also comes the possibility to make a loss, so how has 2020 changed the online trading landscape and how can retail investors stay safe?
Interest rates offered by banks and other traditional forms of consumer investments have been uninspiring for some time, but with the current economic frailty, the Bank of England cut interest rates to an all-time low. This has left many people in search of more exciting and rewarding ways to grow their savings which is indeed something online trading can provide.
When the pandemic hit earlier this year, it was widely reported that user numbers for online trading rocketed due to disappointing savings rates but also because the enforced lockdown gave more people the time to learn a new skill and educate themselves on online trading.
A volatile market certainly offers great scope for profit and new sources of revenue for those that are savvy enough to put their convictions to the test. However, where people stand the chance to profit greatly from market volatility, there is also the possibility to make a loss, particularly for those that are new to online trading or who are still developing their understanding of the market.
The sharp rise in online trading over lockdown paired with this year’s unpredictable global economy has led to some financial losses, but with a number of risk management tools now available this does not necessarily have to be the case.
Protect your assets
Although not yet widely available across the retail market, risk management tools are slowly becoming more prevalent and being offered by online traders as an extra layer of security for those seeking to trade in riskier climates.
There are a range of options available for traders, but amongst the common tools are “take profit” orders in conjunction with “stop loss” orders. A take profit order is a type of limit order that specifies the exact price for traders to close out an open position for a profit, and if the price of the security does not reach the limit price, the take profit order will not be fulfilled. A stop loss order can limit the trader’s loss on a security position by buying or selling a stock when it reaches a certain price.
Take profit and stop loss orders are good for mitigating risk, but for those that are new to the game or who would prefer extra support, there are even some risk management tools, such as AvaProtect, that provide total protection against loss for a defined period. This means that if the market moves in the wrong direction than originally anticipated, traders can recoup their losses, minus the cost of taking out the protection.
Not a day has gone by this year without the news prompting a change in the financial markets. Until a cure for the coronavirus is discovered, we are unlikely to return to ‘normal’ and the global markets will continue to remain highly volatile. In addition, later this year we will witness one of the most critical US presidential elections in history and the UK’s transition period for Brexit will come to an end. The outcome of these events may well trigger further volatility.
Of course, this may also encourage more people to dip their toes into online trading for a chance to profit. As more people take an interest and sign up to online trading platforms, providers will certainly look to increase or improve the risk management tools on offer to try and keep new users on board, and this could spell a new era for the online trading world.
By Paddy Osborn, Academic Dean, London Academy of Trading
Whether you’re negotiating a business deal, playing a sport or trading financial markets, it’s vital that you have a plan. Top golfers will have a strategy to get around the course in the fewest number of shots possible, and without this plan, their score will undoubtedly be worse. It’s the same with trading. You can’t just open a trading account and trade off hunches and hopes. You need to create a structured and robust plan of attack. This will not only improve your profitability, but will also significantly reduce your stress levels during the decision-making process.
In my opinion, there are four stages to any trading strategy.
S – Set-up
T – Trigger
E – Execution
M – Management
Good trading performance STEMs from a structured trading process, so you should have one or more specific rules for each stage of this process.
Before executing any trades, you need to decide on your criteria for making your trading decisions. Should you base your trades off fundamental analysis, or maybe political news or macroeconomic data? If so, then you need to understand these subjects and how markets react to specific news events.
Alternatively, of course, there’s technical analysis, whereby you base your decisions off charts and previous price action, but again, you need a set of specific rules to enable you to trade with a consistent strategy. Many traders combine both fundamental and technical analysis to initiate their positions, which, I believe, has merit.
What needs to happen for you to say “Ah, this looks interesting! Here’s a potential trade.”? It may be a news event, a major macro data announcement (such as interest rates, employment data or inflation), or a chart level breakout. The key ingredient throughout is to fix specific and measurable rules (not rough guidelines that can be over-ridden on a whim with an emotional decision). For me, I may take a view on the potential direction of an asset (i.e. whether to be long or short) through fundamental analysis, but the actual execution of the trade is always technical, based off a very specific set of rules.
To take a simple example, let’s assume an asset has been trending higher, but has stopped at a certain price, let’s say 150. The chart is telling us that, although buyers are in long-term control, sellers are dominant at 150, willing to sell each time the price touches this level. However, the uptrend may still be in place, since each time the price pulls back from the 150 level, the selling is weaker and the price makes a higher short-term low. This clearly suggests that upward pressure remains, and there’s potential to profit from the uptrend if the price breaks higher.
Once you’ve found a potential new trade set-up, the next step is to decide when to pull the trigger on the trade. However, there are two steps to this process… finger on trigger, then pull the trigger to execute.
Continuing the example above, the trigger would be to buy if the price breaks above the resistance level at 150. This would indicate that the sellers at 150 have been exhausted, and the buyers have re-established control of the uptrend. Also, it is often the case that after pause in a trend such as this, the pent-up buying returns and the price surges higher. So the trigger for this trade is a breakout above 150.
We have a finger on the trigger, but now we need to decide when to squeeze it. What if the price touches 150.10 for 10 seconds only? Has our resistance level broken sufficiently to execute the trade? I’d say not, so you need to set rules to define exactly how far the price needs to break above 150 – or for how long it needs to stay above 150 – for you to execute the trade. You’re basically looking for sufficient evidence that the uptrend is continuing. Of course, the higher the price goes (or the longer it stays above 150), the more confident you can be that the breakout is valid, but the higher price you will need to pay. There’s no perfect solution to this decision, and it depends on many things, such as the amount of other supporting evidence that you have, your levels of aggression, and so on. The critical point here is to fix a set of specific rules and stick to those rules every time.
Good trade management can save a bad trade, while poor trade management can turn an excellent trade entry into a loser. I could talk for days about in-trade management, since there are many different methods you can use, but the essential ingredient for every trade is a stop loss. This is an order to exit your position for a loss if the market doesn’t perform as expected. By setting a stop loss, you can fix your maximum risk on a trade, which is essential to preserving your capital and managing your overall risk limits. Some traders set their stop loss and target levels and let the trade run to its conclusion, while others manage their trades more actively, trailing stop losses, taking interim profits, or even adding to winning positions. No matter how you decide to manage each trade, it must be the same every time, following a structured and robust process.
The final step in the process is to review every trade to see if you can learn anything, particularly from your losing trades. Are you sticking to your trading rules? Could you have done better? Should you have done the trade in the first place? Only by doing these reviews will you discover any patterns of errors in your trading, and hence be able to put them right. In this way, it’s possible to monitor the success of your strategy. If your trades are random and emotional, with lots of manual intervention, then there’s no fixed process for you to review. You also need to be honest with yourself, and face up to your bad decisions in order to learn from them.
In this way, using a structured and robust trading strategy, you’ll be able to develop your trading skills – and your profits – without the stress of a more random approach.
Economic recovery likely to prove a ‘stuttering’ affair
By Rupert Thompson, Chief Investment Officer at Kingswood
Equity markets continued their upward trend last week, with global equities gaining 1.2% in local currency terms. Beneath the surface, however, the recovery has been a choppy affair of late. China and the technology sector, the big outperformers year-to-date, retreated last week whereas the UK and Europe, the laggards so far this year, led the gains.
As for US equities, they have re-tested, but so far failed to break above, their post-Covid high in early June and their end-2019 level. The recent choppiness of markets is not that surprising given they are being buffeted by a whole series of conflicting forces.
Developments regarding Covid-19 as ever remain absolutely critical and it is a mixture of bad and good news at the moment. There have been reports of encouraging early trial results for a new treatment and potential vaccine but infection rates continue to climb in the US. Reopening has now been halted or reversed in states accounting for 80% of the population.
We are a long way away from a complete lockdown being re-imposed and these moves are not expected to throw the economy back into reverse. But they do emphasise that the economic recovery, not only in the US but also elsewhere, is likely to prove a ‘stuttering’ affair.
Indeed, the May GDP numbers in the UK undid some of the optimism which had been building recently. Rather than bouncing 5% m/m in May as had been expected, GDP rose a more meagre 1.8% and remains a massive 24.5% below its pre-Covid level in February.
Even in China, where the recovery is now well underway, there is room for some caution. GDP rose a larger than expected 11.5% q/q in the second quarter and regained all of its decline the previous quarter. However, the bounce back is being led by manufacturing and public sector investment, and the recovery in retail sales is proving much more hesitant.
China is not just a focus of attention at the moment because its economy is leading the global upturn but because of the increasing tensions with Hong Kong, the US and UK. UK telecoms companies have now been banned from using Huawei’s 5G equipment in the future and the US is talking of imposing restrictions on Tik Tok, the Chinese social media platform. While this escalation is not as yet a major problem, it is a potential source of market volatility and another, albeit as yet relatively small, unwelcome drag on the global economy.
Government support will be critical over coming months and longer if the global recovery is to be sustained. This week will be crucial in this respect for Europe and the US. The EU, at the time of writing, is still engaged in a marathon four-day summit, trying to reach an agreement on an economic recovery fund. As is almost always the case, a messy compromise will probably end up being hammered out.
An agreement will be positive but the difficulty in reaching it does highlight the underlying tensions in the EU which have far from gone away with the departure of the UK. Meanwhile in the US, the Democrats and Republicans will this week be engaged in their own battle over extending the government support schemes which would otherwise come to an end this month.
Most of these tensions and uncertainties are not going away any time soon. Markets face a choppy period over the summer and autumn with equities remaining at risk of a correction.
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