Alarming Household Debt

Background

Household debt is defined as the amount of money that all adults in the household owe financial institutions. It includes consumer debt and mortgage loans. A significant rise in the level of this debt coincides historically with many severe economic crises and was a cause of the U.S. and subsequent European economic crises of 2007–2012. Several economists have argued that lowering this debt is essential to economic recovery in the U.S. and selected Eurozone countries.

Household debt rose as living standards rose, and consumers demanded an array of durable goods. These included major durables like high-end electronics, vehicles, and appliances, that were purchased with credit. Easy credit encouraged a shift from saving to spending.

Households in developed countries significantly increased their household debt relative to their disposable income and GDP from 1980 to 2007 — one of the many factors behind the U.S. and European crises of 2007–2012. Research indicates that U.S. household debt increased from 43% to 62% of GDP from 1982 to 2000.[5]

U.S. households made significant progress in deleveraging (reducing debt) post-crisis, much of it due to foreclosures and financial institution debt write-downs. By some measures, consumers began to add certain types of debt again in 2012, a sign that the economy may be improving as this borrowing supports consumption.

https://en.wikipedia.org/wiki/Household_debt

Reference Materials – Household Debt

A rise in the household debt to GDP ratio predicts lower output growth and a higher unemployment rate over the medium-run.

http://faculty.chicagobooth.edu/workshops/macro/pdf/MianSufiVerner_worlddebt.pdf

The Great Recession was particularly severe in economies that experienced a larger run-up in household debt prior to the crisis. A further negative effect on economic activity of high household debt in the presence of a shock, postulated by numerous models, comes from the forced sale of durable goods. For example, a rise in unemployment reduces households’ ability to service their debt, implying arise in household defaults, foreclosures, and creditors selling foreclosed properties at distressed, or fire-sale, prices. Estimates suggest that a single foreclosure lowers the price of a neighboring property by about 1 percent, but that the effects can be much larger when there is a wave of foreclosures, with estimates of price declines reaching almost 30 percent (Campbell, Giglio, and Pathak, 2011). The associated negative price effects in turn reduce economic activity through a number of self-reinforcing contractionary spirals. These include negative wealth effects, a reduction in collateral value, a negative impact on bank balance sheets, and a credit crunch. As Shleifer and Vishny (2010) explain, fire sales undermine the ability of financial institutions and firms to lend and borrow by reducing their net worth, and this reduction in credit supply can reduce productivity enhancing investment. Such externalities—banksand households ignoring the social cost of defaults and fire sales—may justify policy intervention aimedat stopping household defaults, foreclosures, and fire sales. The case of the United States today illustrates the risk of house prices “undershooting” their equilibrium values during a housing bust on the back of fire sales. The IMF staff notes that “distress sales are the main driving force behind the recent declines in house prices—in fact, excluding distress sales, house prices had stopped falling” and that “there is a risk of house price undershooting”.

https://www.imf.org/external/pubs/ft/weo/2012/01/pdf/c3.pdf

United States

US_HSD.png

US’s household debt-to-GDP hits as high as more than 95% before the global financial crisis hit in 2007-2008. Since recession, there has been significant deleveraging within the US financial sector.

http://www.tradingeconomics.com/united-states/households-debt-to-gdp

Greece

Greece experienced its highest household debt-to-GDP ratio of close to 65%. On June 30, 2015, it became the first developed country to fail to make an IMF loan repayment.

greece-households-debt-t.png

Malaysia

Malaysia’s and Thailand’s household debt to GDP ratios have almost doubled between 2008 and 2015. Thailand’s ratio stands at about 80%.

household-debt-to-income_620_403_100.jpg

Bank Negara recently announced that Malaysia’s household debt-to-gross domestic product (GDP) ratio increased to 89.1% as of 2015 from 86.8%.

http://www.thestar.com.my/business/business-news/2016/04/02/household-debt-on-the-rise/

With recent massive retrenchment exercises in Malaysia (especially with the O&G sector), we are seeing an increasing rise in unemployment rate:

IUnemployment Rate_MY.png

Furthermore, Malaysia is experiencing a slowing GDP growth rate in tandem with domestic and global uncertainties.

MY_GDP.png

Final Words: It Is A Matter Of Time

Fitch downgraded Malaysia’s long-term local bonds’ credit rating to “A-” from “A” last week. The key factors now absent in Malaysia are strong public finance fundamentals against external finance fundamentals, and the erstwhile preferential treatment of local-currency creditors against the foreign-currency ones.

http://www.theedgemarkets.com/my/article/fitch-downgrades-petronas-long-term-credit-ratings-after-msias-downgrade

It is a matter of time when Malaysia’s high households debt to GDP will lead to significant problems in the domestic economy, including a likelihood of a recession in the medium term.

So when is the breaking point for Malaysia?

  1. When interest rate rises (unlikely the case at this juncture) : harder for Borrowers to meet debt service obligations
  2. Falling property prices : will affect collateral value pledged to property loans
  3. Falling GDP leads to increasing unemployment rate
  4. Rising NPLs, potentially resulting in the shutoff of credit environment
  5. Budget deficits and fiscal issues
  6. Global externalities

DISCLAIMER: ALL ARTICLES CONTAINED IN THIS SITE ARE FOR INFORMATION AND ILLUSTRATIVE PURPOSES ONLY AND DOES NOT PURPORT TO SHOW ACTUAL RESULTS. IT IS NOT, AND SHOULD NOT BE REGARDED AS INVESTMENT ADVICE OR AS A RECOMMENDATION REGARDING ANY PARTICULAR SECURITY OR COURSE OF ACTION. SOURCES USED IN THIS SITE HAVE NOT BEEN INDEPENDENTLY VERIFIED FOR ACCURACY. YOU SHOULD SEEK INDEPENDENT AND PROFESSIONAL INVESTMENT ADVICE IN REGARD TO YOUR INVESTMENT DECISIONS. THE AUTHOR MAY HOLD POSITIONS IN THE SECURITIES MENTIONED ABOVE. 

Keep Going Up?

The Stock Exchange of Thailand (“SET”) has recorded impressive return since the start of 2016, with its trading pattern backed by an upward trend line and support as per the 200D-MA.

Thai SET Index_Jul 16.jpeg

On a fundamental front, SET may appear overvalued, with its price-to-earnings ratio (PER) exceeding 20 times (which is significantly higher than its historical average of 14.45 times since 1989).

PER_Graph.png

From another angle, the price-to-book ratio (PBR) of the SET is currently at a reasonable valuation point of 1.86 times which is relatively lower than historical average of 2.20 times (since 1989).

PBR_Graph.png

In addition, the current dividend yield of SET of 3.29% is relatively higher than historical average of 3.02% (in another words, the valuation of SET appears reasonable at this point in time).

Div_Yield.png

The reasonable dividend yield of SET is supported by an increasing dividend payout ratio of SET since 2000:

Div_Payout.png

On a separate note, we are seeing a decreasing return on equity, ROE for SET (i.e below 10%). The higher dividend payout trend may have potentially led to lower funds being retained in the companies for business expansion / growth, which in turn will affect future earnings / profitability of the listed companies.

ROE_Graph.png

Furthermore, the market cap-to-GDP for SET appears to be on the higher side at this juncture (signifying potential overvaluation):

Mkt Cap to GDP_Thai.png

Statistical Test 1: P/E vs ROE

PER vs ROE_2.png

PER vs ROE_1.png

PER vs ROE_3.png

In summary – based on the relationship PER vs ROE, it appears that PER of SET of 21.96x is relatively higher than the forecasted PER of 18.64x (signifying potential overvaluation of SET)

Statistical Test 2: P/E vs Dividend Payout

PER vs DivPyt_2.png

PER vs DivPyt_1.png

PER vs DivPyt_3.png

In summary – based on the relationship PER vs Dividend Payout Ratio, it appears that PER of SET of 21.96x is relatively higher than the forecasted PER of 20.64x (signifying potential overvaluation of SET). The statistical relationship based on dividend payout ratio is relatively strong if compared to PER vs ROE.

Statistical Test 3: PBR vs ROE

PBR vs ROE_2.png

PBR vs ROE

PBR vs ROE_3.png

In summary, the statistical relationship of PBR vs ROE appears weak. Based on this statistical relationship, the current PBR of SET of 1.86x is marginally lower than its forecasted value of 1.97x.

Final Words

On a weight of “evidence”, SET appears potentially overvalued. Further, we may see future headwinds affecting the Thailand’s economy:

In the 2016 Thailand Economic Monitor released today by the World Bank, fiscal stimulus and tourism are highlighted as the key drivers of economic growth in Thailand, but the economy still faces headwinds on the path to a broad-based and sustained recovery. The slowdown has exposed structural challenges in implementing public investment, maintaining or raising export competitiveness, and addressing skills mismatches, the report said. The aging of the working-age population will begin to affect the Thai economy within the next five years. Kiatipong Ariyapruchya, senior country economist, noted that due to the issue of ageing, Thailand’s working population would shrink by 11 per cent from now until 2040, from 49 million to 40 million. He noted that major headwinds to the Thai economy would also involve a possible delay in mega projects as well as low export competitiveness. In the first quarter, public spending and tourism were major contributors of Thailand’s ecomic growth.

http://www.nationmultimedia.com/breakingnews/Thailands-economy-expected-to-grow-2-5-in-2016-30289300.html

DISCLAIMER: ALL ARTICLES CONTAINED IN THIS SITE ARE FOR INFORMATION AND ILLUSTRATIVE PURPOSES ONLY AND DOES NOT PURPORT TO SHOW ACTUAL RESULTS. IT IS NOT, AND SHOULD NOT BE REGARDED AS INVESTMENT ADVICE OR AS A RECOMMENDATION REGARDING ANY PARTICULAR SECURITY OR COURSE OF ACTION. SOURCES USED IN THIS SITE HAVE NOT BEEN INDEPENDENTLY VERIFIED FOR ACCURACY. YOU SHOULD SEEK INDEPENDENT AND PROFESSIONAL INVESTMENT ADVICE IN REGARD TO YOUR INVESTMENT DECISIONS. THE AUTHOR MAY HOLD POSITIONS IN THE SECURITIES MENTIONED ABOVE. 

What should we expect in August?

As per my first post on this site (https://kenutau.wordpress.com/2016/02/06/august-negative-month-for-fbmklci/) , on a balance of probability, we should anticipate the general indices to record a negative month-to-month return for the month of August.

Key dates to watch out in the month of August for Malaysia:

5 Aug 2016 Release of BNM Statement of Accounts as at 29 Jul 2016
12 Aug 2016 Release of 2nd Quarter 2016 GDP
22 Aug 2016 Release of BNM Statement of Accounts as at 15 Aug 2016
30 Aug 2016 Release of Monthly Statistical Bulletin July 2016
30 Aug 2016 Release of Detailed Disclosure of International Reserves as at end July 2016
Source http://www.bnm.gov.my/index.php?ch=en_event

What We Can Learn From Past Historical Trading Patterns of FBMKLCI (Jul-Aug)

2015: Decline in FBMKLCI commenced on 6 August 2015, with the index having traded below its 20D-MA and 50D-MA. There was a subsequent upward reversal on 25 August 2015. Prior to the decline on 6 Aug 2015, the FBMKLCI has been trending range bound in the month of July, with volume that was relatively lower if compared to the August trading month. Another key observation is that prior to the drop in August, the FBMKLCI was trading below that of its 50D-MA and 200D-MA. The 3 MAs lines were pointing downward for month July prior to the decline in August.

Aug_2015.jpeg

2014: Similar to 2015, the month-to-month decline in FBMKLCI commenced on 6 August 2014.  However, it has a relatively shorter time frame of decline prior to a upward reversal since there was a major decline on 8 August 2014. Prior to the decline, the FBMKLCI has been trending around 20D-MA and 50D-MA, but above its 200D-MA. There is no material difference in terms of volume for both July and August. The 20D and 50D MAs were pointing downward prior to the decline, whilst 200D MA was maintaining an upward trend.

Aug_2014

2013: Similar to 2014, prior to the decline, the FBMKLCI has been trending around its 20D-MA and 50D-MA, but above its 200D-MA. It has two major significant declines, with the first decline commencing end July and another major decline was recorded on 20 August 2013. Rebound or upward reversal happened at a later stage in early September. Volume was significant in 3rd week of August onwards. The 20D and 50D MAs were pointing downward prior to the decline, whilst 200D MA was maintaining an upward trend. 20D MA actually crossed below the 50D MA in July.

Aug_2013.jpeg

2012: Unlike 2015,2014 and 2013, 2012 recorded a positive trend for the month of August. The subsequent decline happened in the month of September. The FBMKLCI has been trending above 20D, 50D and 200D MAs. Three MAs were all pointing upward, with significant support in between the lines.

Aug_2012.jpeg

What about August 2016?

Aug_2016.jpeg

  • It will depend on whether the FBMKLCI is able to continue trading above its 200D MA resistance line. If yes, we may potentially see a continuing upward trend for FBMKLCI with 3 MAs potentially pointing upward (contrast: 2015 / 2014 / 2013).
  • We saw some positive upward movement in FBMKLCI when the 20D MA crosses above 50D MA lately.
  • Potential support line at 1,612
  • Volume has been ‘quiet’ for month of July

 

DISCLAIMER: ALL ARTICLES CONTAINED IN THIS SITE ARE FOR INFORMATION AND ILLUSTRATIVE PURPOSES ONLY AND DOES NOT PURPORT TO SHOW ACTUAL RESULTS. IT IS NOT, AND SHOULD NOT BE REGARDED AS INVESTMENT ADVICE OR AS A RECOMMENDATION REGARDING ANY PARTICULAR SECURITY OR COURSE OF ACTION. SOURCES USED IN THIS SITE HAVE NOT BEEN INDEPENDENTLY VERIFIED FOR ACCURACY. YOU SHOULD SEEK INDEPENDENT AND PROFESSIONAL INVESTMENT ADVICE IN REGARD TO YOUR INVESTMENT DECISIONS. THE AUTHOR MAY HOLD POSITIONS IN THE SECURITIES MENTIONED ABOVE. 

Are We In A Recovery?

CycleInvesting.png

Every business cycle is different in its own way, but certain patterns have tended to repeat themselves over time. Fluctuations in the business cycle are essentially distinct changes in the rate of growth in economic activity, particularly changes in three key cycles—the corporate profit cycle, the credit cycle, and the inventory cycle—as well as changes in the employment backdrop and monetary policy. While unforeseen macroeconomic events or shocks can sometimes disrupt a trend, changes in these key indicators historically have provided a relatively reliable guide to recognizing the different phases of an economic cycle. https://www.fidelity.com/viewpoints/investing-ideas/business-cycle-investing

Where is Malaysia now (from a cycle investing perspective)?

1- Interest Rate Rising

InterestRateHike.png

In July 2014, Bank Negara Malaysia (BNM) hiked its overnight policy rate by 25 basis points to 3.25 percent, after keeping it steady since mid-2011. http://www.cnbc.com/2014/07/10/entral-bank-raises-rates-to-help-debt.html

2- Falling Share Price

KLCI Declines.png

3- Falling Commodity Prices

Malaysia depends on two key commodities, crude oil and crude palm oil (CPO) to drive its exports. Crude oil has declined significantly since 2014.

Crude Oil.png

CPO has since recovered after experiencing significant decline from 2014 onwards.

CPO.png

4- Falling Overseas Reserves

We have seen a drop in foreign reserves of BNM:

Forex.png

5- Tighter Money 

Tighter credit lending in the property sectors:

Malaysians are finding it increasingly harder to get housing loans as banks have less money available to lend out, financial expert Gary Chua said today. Chua, who heads financial education firm Smart Financing, said the housing loan approval rate, which was at least 65 per cent about seven years ago, has been showing a downward trend this year with banks rejecting a higher number of applications. He said statistics show that the 53 per cent of loan approvals by banks in the first quarter slid to just 47 per cent for residential property loan approvals in the third quarter.

– See more at: http://www.themalaymailonline.com/money/article/financial-expert-tougher-to-get-housing-loans-as-bank-funds-dry-up#sthash.kT6agKYg.dpuf

6- Falling Real Estate Values

The prices of houses could fall further as developers and the secondary property market grapple with the softening demand and the absence of speculators who had been snapping up properties over the last few years. Prices of residential properties declined 4.7% in the first-quarter (1Q) of 2015 and had fallen around 3% so far this year, said RHB Research Institute Sdn Bhd analyst Loong Kok Wen.“If the economy worsens next year, prices of residential properties as a whole could slump by 3% to 5% in 2016.“Residential properties in Iskandar Malaysia, Johor, could see a double-digit price decline next year while prices in the Klang Valley may drop in the single digit,” the analyst told The Malaysian Reserve yesterday

http://www.themalaysianreserve.com/new/story/secondary-property-market-faces-price-fall

7- Falling Interest Rate

13 July 2016: Bank Negara Malaysia has unexpectedly reduced the Overnight Policy Rate (OPR) by 25 basis points to 3% at its Monetary Policy Committee (MPC) meeting on Wednesday, citing rising risks from Britain’s exit from the European Union. It said on Wednesday the ceiling and floor rates of the corridor for the OPR are correspondingly reduced to 3.25% and 2.75% respectively. This move could see banks lowering their lending rates and making it cheaper for eligible consumers and companies to take loans. Correspondingly, the saving rates could also go down. 

http://www.thestar.com.my/business/business-news/2016/07/13/bnm-cuts-opr-to-3pct-at-its-monetary-policy-committee/

What Are The Sectors That Can Be Considered If We Are REALLY In A Recovery

business-cycle-2.jpg

Final Words

Our brief analysis is very much of a domestic focus, without significant consideration for external factors. The uncertainties in the global environment could potentially weigh on Malaysia’s growth prospects and hence, the question of whether we are in recovery or not will ultimately depend on the overall health and prospects of the global economy.

 

DISCLAIMER: ALL ARTICLES CONTAINED IN THIS SITE ARE FOR INFORMATION AND ILLUSTRATIVE PURPOSES ONLY AND DOES NOT PURPORT TO SHOW ACTUAL RESULTS. IT IS NOT, AND SHOULD NOT BE REGARDED AS INVESTMENT ADVICE OR AS A RECOMMENDATION REGARDING ANY PARTICULAR SECURITY OR COURSE OF ACTION. SOURCES USED IN THIS SITE HAVE NOT BEEN INDEPENDENTLY VERIFIED FOR ACCURACY. YOU SHOULD SEEK INDEPENDENT AND PROFESSIONAL INVESTMENT ADVICE IN REGARD TO YOUR INVESTMENT DECISIONS. THE AUTHOR MAY HOLD POSITIONS IN THE SECURITIES MENTIONED ABOVE. 

A tale of two bourses (part 2)

Briefly discussed a comparison between Malaysia’s KLCI and Singapore’s STI in my earlier post: https://kenutau.wordpress.com/2016/02/12/a-tale-of-two-bourses/

In this part 2, let’s explore historical trend of the market cap to GDP ratio for both Malaysia and Singapore.

Malaysia

As shown below, the Malaysian stock market crash during 97-98 was much anticipated, as the  market was trading as high as more than 300% market cap-to-GDP (1993-1996). For period between 1999 and 2007, the ratio has been range bound with an average of 142%. The 2008 financial crisis had pushed the ratio down to 81% (which is the lowest) since 1989. For period between 2009 and 2015, the average ratio was approximately 145%, which was slightly higher than the average ratio for the period 1999-2007. Unless we see significant contraction in future GDP or global recession, the Malaysian stock market will continue to trade range bound in line with GDP growth rate. 

MktCapToGdp_MYMIDF Research has lowered its forecast for Malaysia’s year 2016 gross domestic production (GDP) growth to 4.0%, following a cut in its growth forecast for the second quarter of 2016 to 3.9%.

In a note today, the research house said the leading indicator which provides a forecast of Malaysia’s economy two quarters ahead, fell 2.6% year-on-year, sinking to levels seen in 1997, 2000 and 2008.

However, it said the decline is rather gradual, compared to the sharp decline in prior crises.

“We believe that a prolonged economic slowdown is likely; hence we are revising our GDP forecast for 2Q16 from 4.2% to 3.9%, and for the full year 2016 from 4.4% to 4.0%,” said MIDF.

http://www.theedgemarkets.com/en/node/289827

Singapore

Singapore’s market cap to GDP ratio exhibits an increasing market cap-to-GDP ratio and relatively more volatile if compared to Malaysia. This could be due to its characteristics (1) openness of the economy (2) more developed stock market and better liquidity (3) developed nation (lower annual GDP growth).  Recent corrections in Singapore stock market had led to a lower ratio  of 213% (as of 2015). As long as Singapore continues to record annual GDP growth, the ratio is expected to hover between 200-250. In the event of a global crisis, we should see a decline in the stock market far greater than of Malaysia. MktCapToGdp_SG.png

According to the 22 respondents in the latest quarterly survey by the Monetary Authority of Singapore, the Gross Domestic Product (GDP) is expected to expand 1.8 percent this year. This estimate is slightly lower than the 1.9 percent forecast which was projected in March.

However, growth is still within the mark of 1 to 3 percent official forecast. The estimate shows that the GDP can potentially grow at 2.1 percent next year.

The manufacturing sector will contribute about one-fifth of the republic’s GDP.  The finance, insurance as well as wholesale and retail trade sectors will expand 2.9 percent and 2.0 percent respectively. However, the previous expectation was of an increase up to 3.6 percent and 3.9 percent respectively.

http://www.ibtimes.sg/economists-trim-singapore-gdp-growth-projection-1-8-this-year-1933

DISCLAIMER: ALL ARTICLES CONTAINED IN THIS SITE ARE FOR INFORMATION AND ILLUSTRATIVE PURPOSES ONLY AND DOES NOT PURPORT TO SHOW ACTUAL RESULTS. IT IS NOT, AND SHOULD NOT BE REGARDED AS INVESTMENT ADVICE OR AS A RECOMMENDATION REGARDING ANY PARTICULAR SECURITY OR COURSE OF ACTION. SOURCES USED IN THIS SITE HAVE NOT BEEN INDEPENDENTLY VERIFIED FOR ACCURACY. YOU SHOULD SEEK INDEPENDENT AND PROFESSIONAL INVESTMENT ADVICE IN REGARD TO YOUR INVESTMENT DECISIONS. THE AUTHOR MAY HOLD POSITIONS IN THE SECURITIES MENTIONED ABOVE. 

Hot Money (Part 2)

Hot Money & South East Asian Stock Markets

Briefly touched on real interest rate and hot money in an earlier post: https://kenutau.wordpress.com/2016/02/12/real-interest-rate-hot-money/

BREXIT has certainly thrown a spanner into US Fed’s gradual plans in raising the fed funds rate. In fact, there may even be a rate cut in view of the prevailing uncertainties associated with BREXIT (http://fortune.com/2016/06/27/fed-interest-rate-brexit/).

Hot money from global quantitative easing programme has since created significant upward pressure on the asset prices of emerging markets (especially with South East Asian stock markets). Assuming a surprise rate hike or hike in market volatility this year, the South East Asian stock markets will potentially see a significant downward reversal due to flow of funds back to US assets.

Hot Money_10 Year_Jul16.jpeg

The magnitude of historical increase in the indices of respective stock markets will determine the extent of potential future reversal of these indices. From the above graph, it appears that the Jakarta Composite Index (“JCI”) has recorded the best relative performance since 2006 with more than 270% increase in its index, outperforming the rest of the selected South East Asian stock markets and S&P 500. Both Thailand’s SET and Malaysia’s KLCI have recorded relative performance of 110% and 78% respectively whilst S&P 500 only increased approximately 65%. Meanwhile, Singapore’s STI recorded a marginal increase of 17% since 2006.

Since 2011, the S&P500 has outperformed the selected South East Asian stock markets. Both SET and JCI have performed at 32% and 26% respectively whilst Singapore underperformed at negative 9%.

Hot Money_5 Year_Jul16.jpeg

In the past two years, both Malaysia and Singapore have underperformed at more than negative 10% whilst JCI is the only selected South East Asian stock market that has a positive relative performance.

Hot Money_2 Year_Jul16.jpeg

In one year timeframe, all selected South East Asian markets have corrected, i.e recording negative returns.

Hot Money_1 Year_Jul16

Final Words

This is a simple analysis without a detailed account of each country’s macroeconomic fundamentals. Nevertheless, it does present an angle to identify potential reversals in selected stock markets. JCI appears to be potentially most vulnerable whilst Singapore may appear to be resilient towards future correction.

DISCLAIMER: ALL ARTICLES CONTAINED IN THIS SITE ARE FOR INFORMATION AND ILLUSTRATIVE PURPOSES ONLY AND DOES NOT PURPORT TO SHOW ACTUAL RESULTS. IT IS NOT, AND SHOULD NOT BE REGARDED AS INVESTMENT ADVICE OR AS A RECOMMENDATION REGARDING ANY PARTICULAR SECURITY OR COURSE OF ACTION. SOURCES USED IN THIS SITE HAVE NOT BEEN INDEPENDENTLY VERIFIED FOR ACCURACY. YOU SHOULD SEEK INDEPENDENT AND PROFESSIONAL INVESTMENT ADVICE IN REGARD TO YOUR INVESTMENT DECISIONS. THE AUTHOR MAY HOLD POSITIONS IN THE SECURITIES MENTIONED ABOVE. 

How Low Will Pound Go?

On 10 June 2016, I made a prediction on the outcome of the UK referendum which turned out to be quite accurate, with the projected “remain” percentage to be quite close to the actual number. Refer to my post:  https://kenutau.wordpress.com/2016/06/10/brexit-is-very-real/

Post-referendum, we saw a significant decline in Pound / GBP against the USD (current rate at 1.33):

Pound_1.png

Latest news: http://www.cnbc.com/2016/06/27/major-banks-cut-sterling-forecasts-after-brexit-vote.html

The currency hit its lowest in nearly 31 years in the early hours of Friday after the referendum results were announced that sent shockwaves across all asset classes globally. However, on Monday sterling further fell below the 31-year low to $1.3221 on speculation that the Bank of England may proceed with a rate cut. Sterling is also at its lowest against the euro since March 2014 at 83.41 pence.

“The move in sterling against the dollar after the U.K. referendum is unprecedented,” John Bilton, global head of multi-asset strategy at JP Morgan Asset Management told CNBC via email

A number of banks have cut their sterling forecast since the vote to leave the EU was announced on Friday. HSBC was the first to announce a change to its sterling outlook. The bank said it expects the currency to fall to $1.25 against the dollar in the third quarter and to $1.20 by year-end.

 

So how low can GBP go?

Since UK is well-connected with the EU region, let’s explore the historical relationship between USD/GBP and EUR/USD to determine the potential trading range of USD/GBP. We did a quick regression analysis between the two currencies for data points (since 1 Jan 1999) and the summary of the results is shown as follows:

Pound_4.png

As shown below, the actual USDGBP rate is trading relatively lower than of the forecasted rate of USDGBP based on the results of the regression analysis.

Pound_2.png

As summarised below, the current rate of 1.33 is below the forecasted rate of 1.5881 and it is very close to the lower bound of the 95% confidence interval of 1.3187 – 1.8576.

Pound_3.png

If you believe that the market has overreacted to BREXIT, the Pound / GBP is poised to rebound. Further, based on a 95% confidence interval, the downside risk is fairly limited. Nevertheless, since BREXIT is an unprecedented event, the ordinary statistical analysis may not be able to capture the full extent of market events resulting from BREXIT.

DISCLAIMER: ALL ARTICLES CONTAINED IN THIS SITE ARE FOR INFORMATION AND ILLUSTRATIVE PURPOSES ONLY AND DOES NOT PURPORT TO SHOW ACTUAL RESULTS. IT IS NOT, AND SHOULD NOT BE REGARDED AS INVESTMENT ADVICE OR AS A RECOMMENDATION REGARDING ANY PARTICULAR SECURITY OR COURSE OF ACTION. SOURCES USED IN THIS SITE HAVE NOT BEEN INDEPENDENTLY VERIFIED FOR ACCURACY. YOU SHOULD SEEK INDEPENDENT AND PROFESSIONAL INVESTMENT ADVICE IN REGARD TO YOUR INVESTMENT DECISIONS. THE AUTHOR MAY HOLD POSITIONS IN THE SECURITIES MENTIONED ABOVE.