Looking for contributors! #fx #trading #economics

Image result for writing

I’m always looking for contributors to my site and I am always looking to contribute to others as well.

Whether the topic is trading, economics or anything in between, I’d be more than happy to share the content here and write for your site.

Please email me at dbelle@davidbellefx.com with an article proposal or message me on Twitter.

I look forward to hearing from you.

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Is it better to rent or buy? The big question.

Image result for london house

This is a question that I have seen various times on social media. I’ll get to the point. My feeling is that buying is an idea that has been pushed heavily over the years by those who have bought their house for very cheap and who have seen it appreciate heavily. In addition, the majority of retail banks’ business is in the mortgage market where they glean interest through mortgage provision. You only have to look to the most recent financial crisis to see how far reaching the mortgage business is.

I wrote a recent article on London house pricing and why they have increased so heavily. A basic summary is that a combination of banks allowing less leverage & therefore a bigger initial deposit has increased rate of renting while low interest rate policy, quantitative easing and low housing stock has caused the price rise. This has caused people to rent more, yet it seems their real goal is to own a home. Why?

This article was taken from here.

Dear Emily,

I’m 30 years old, and my husband and I are thinking about buying a house. He’s all for it, but frankly, I’m terrified of the idea of taking on a mortgage. I know a number of people who lost their homes during the financial crisis. The housing market seems like it isn’t the sure thing everyone said it was. And we have significant student loan debt as it is. So my question is—is homeownership really all it’s cracked up to be? And what should young people do when they’re already swimming in debt as is?

Dear Renter:

I distinctly remember the time in 2006 when a relative told me I should “definitely” buy a house because “the housing market always goes up.” This was obviously not good advice, though it certainly reflects prevailing wisdom at the time. And I can see why in the wake of the housing crisis, you’d fear that the housing market always goes down. Which is also not true.

There is one unambiguous argument in favor of buying a house: Sometimes it is hard to rent the house you want. In most places, if you want to live in a single-family detached house, there are not many rental options, certainly not long-term ones. So you may find yourself coming up short on good rentals, and buying may be the only way to get what you want.

However, let’s assume that you are happily renting someplace and your only motivation to buy is financial. Is it cheaper to rent or buy? In equilibrium, the answer is: The price to rent or buy should be about the same. Why is that?

Imagine that rents were so high that you could buy a place and rent it out and still have loads of money left over—even after paying the mortgage, maintenance, and everything else. If that happens, the market will adjust. People will start coming in, buying properties, and renting them out. But as apartment-hunters have more options to choose from, rental prices will fall. And they’ll fall to the point where the rental price just about covers the cost of owning.

Alternatively, if rents were so low that owners would lose money renting houses, they’d stop doing it. But as the number of available rentals goes down, the prices will go up. And they’ll go up to the point where the rental price will cover the cost of owning.

This is an example of what economists call “equilibrium” and it means that ultimately, it will likely cost you about the same to rent or to buy.

You can also try to do this calculation directly. Think about what it costs you to rent. Then think about what it would cost to buy the same quality house. Take into account the mortgage, of course, but also insurance, maintenance, foregone interest on the down payment, and the value of your time spent fixing things that the landlord would fix in a rental. I suspect you’ll find that the costs are about the same.

Given this reality, the only other strong argument for buying a house is the view that the “housing market always goes up,” so when you sell, you’ll make money. But you don’t have to go very far back in history to see that isn’t true, so it’s probably not a great argument. The housing market also doesn’t always go down, so that’s not a great argument, either.

As to your debt question: Student debt may limit your ability to get a mortgage, but it shouldn’t keep you from buying a house if you want to. Your housing debt is collateralized by your house, so unless the value of your house goes down so much that you’re underwater on your mortgage, it’s not debt in the same sense that your student debt is.

A final note: Time horizon matters. There are a lot of fixed costs with buying a house: you pay the realtor, closing costs, etc. If you are going to own a house for 30 years, these do not matter much. But if you’re planning to sell in a few years, they significantly raise the effective buying price. And if you rent, so much the easier to flee the coming war with Australia.

There are various reasons why someone may want to buy a home as seen above. I am of the opinion that the initial outlay of a down payment could be better invested elsewhere. Note that any 20 year period of investing (and reinvesting dividends) in the SP500 has only led to a profit. See here:

If the rationale for buying is that you have an investment in the end then in my opinion, it holds up as pretty weak. If you add in the costs associated with being a mortgage borrower (interest payments, maintenance, insurance, renovation etc), would you be able to achieve a 246% return in a 20 year period? This is one huge opportunity cost, as well as being a very illiquid one.

I understand the above is great hindsight analysis, but the fact is that no one has ever lost money over a 20 year period while investing in the SP500 (as long as we are calculating purely from the principle investment, and with dividends reinvested). Many people have lost money on home ownership due to it being an illiquid asset.

Of course, you are able to release equity in your home to finance other investments, however this is not necessarily a given investment strategy in the future due to no knowledge of future house price appreciation or viability for remortgaging. And this brings me onto the next point.

Buying may be seen as more attractive, but what % of your income does your mortgage take up? Rent may be £1500 and a mortgage £1300, but would your emergency fund be able to cover mortgage payments if you lost your job? What if you’re utilising 60% of your income paying a mortgage plus home ownership costs? Renting provides a certain flexibility in an economic climate where the future is very uncertain. If you lose your job, you can quickly move to somewhere with lower payments, and avoid a very big mess.

At the end of the day, there are personal circumstances that come into it. But always bear in mind opportunity cost and longer term costs that may not be associated with renting.


‘I refuse to pay someone’s mortgage’

But you don’t mind giving banks interest payments? Interesting (ha).

Remember, mortgage in French means ‘death pledge’. Obviously death in this sense means until the loan obligation ends, but there are funny connotations with it as well.

A mortgage is classes as a liability until it’s paid off. A house is not an asset until that obligation is fulfilled. In addition, considering buying a home as an investment is poor, since house prices have barely outpaced inflation over the last 60 years. This does not make it a poor purchase, however.


The following video gives a roundup of what I have said:

Note, the mortgage calculation equation is wrong. It should be E = P×r×(1 + r)n/((1 + r)n – 1),  where E = monthly payment owed to the bank, P$ = loan amount, r = interest rate of loan, n = amount of months loan is for

 

Let me know your thoughts in the comments, on Twitter and below.

How to trade big moves – don’t, but do.

Study the following charts. These are the Referendum moves but work for extended and strong, thin moves as well due to the volume mechanics which I will explain at the end. The reason I say don’t but do, is because it’s best to trade the retrace.

cadjpy6thjuly

gbpchf6thjuly

gbpaud6thjulyeurusd6thjuly

Enter blindly on big moves that reject the 50% level. To plot the fib, you take the open of the candle at the start of the big move and end it at the wick of the end of the big move. You can use discretion if the move is close enough to the 50% level of the move (or if it breaks it and still rejects it). Optimum entry is a close exactly on the 50% level.

Stops are placed at the next fib level above if buying or below if selling (the 61.8% level or the 38.2% level).

Take profit is at the return to the range of the move, i.e the newly generated support level at the wick of the end of the big move. You can then use discretion to add to your position, or move stops to just above the first take profit level.

Why does this work?

gbchf6thjuly-NFP

Volume is key here. I shall explain in terms of the histogram (volume profile) on the side. Price ends up bouncing at areas of high volume as there are resting orders, people taking profits and new entrants into the market (trading at higher volume areas  is cheaper for big participants – less slippage due to there being more participants at these levels).  On the flip side, the 50% level almost always has a big void of low volume. Price can slip through this, but when there is very limited volume to trade into and when the trend is very strong in one way (made apparent by the big thin move), price tends to continue with the trend.

Here are the stats on the strategy taken on a daily & H4

time frame over 15 months:

The Sharpe Ratio could be better, but the strategy can be optimised further. The frequency of trades ranged between 1-4 per month.

Try it out and see how it works. It’s pretty simple which I quite like.

(Article originally written in August 2016).

The UK property market is a bubble.

Image result for london house

For the last 10 years, London has been experiencing a massive rise in house prices. It’s practically impossible for a first time buyer to get on the ladder – banks don’t want to lend with as much leverage (the money borrowed relative to salary, credit rating and initial down payment) and this is seriously pricing out buyers young and old.

The issue is certainly countrywide, however, London buyers face the biggest hit as seen by the following chart.

hometrack

Source: Hometrack.com

The dashed line is the UK housing price index; the filled line is London’s housing price index. There is roughly a 75% difference between the two measures (at current levels).

But why has this happened? If we note the above chart we see that the recent acceleration began from about 2009/10. During this period, the Bank of England had decreased interest rates to their lowest level ever and had introduced something known as Quantitative Easing. I won’t go too deep into the intricacies of it*, but they end up increasing the amount of money in circulation to boost consumer spending and increase inflation to try and normalise the economy after the 2008 crash. If you can’t get a good return on your money by leaving it in a bank account (interest rates are too low) then where is the next best place? Property. London is the draw for these people with cash holdings in the UK.

*For those who may understand this part: during QE, the central bank purchases bonds from institutions (banks, pension funds, hedge funds) in order to service government spending (the Northern Rock, RBS bailout etc). What do these institutions do with the cash? Re-invest into other assets (property, private equity etc. since the yield on bonds is so low it’s not in their interest to re-enter that asset class as heavily). This is also why the stock markets have been rallying while earnings data for companies have been extremely poor.

So what happens when you can’t afford to buy? You’re forced to rent. Home ownership last year dropped to its lowest rate in 30 years. In February 2016, it had fallen to 58% in London. London’s peak ownership during the housing boom of the early 2000s was 64% and England’s was 71%. Peak ownership and the new ownership as of Feb last year is shown by the following chart.

home2

Source: The Guardian (data from The Resolution Foundation)

I don’t want to get too political/ideological here, but what this shows is a transfer of wealth from the ‘haves’ (landlords, pension funds who own property etc) to the have nots (first time buyers, young people). Additionally, remember Margaret Thatcher’s ‘Right to Buy’ scheme? People were able to buy their council houses at a massive discount – 20 years later they’re worth 4/5 times more. This disturbance of the supply/demand dynamic has not helped with the velocity of long term price increases.

Additionally, foreign investors have caused a massive rise in London house prices especially. Above I mentioned investors using property as cash holdings, but why else? Well, the appreciation of London property far outweighs the rate of inflation in a relatively short time horizon. This means that the cash they have used on the property appreciates by the difference between inflation and annual appreciation, minus any costs from taxes/solicitors etc. For them, it’s merely a bank account which is going to give a better rate of return than a traditional account, be less risky than investing in stocks or shares and much of the time, and they can get around capital controls in their countries (see RussiaChina etc).

What this also shows is another massive longer term issue which is low wage growth. Relative to our (I was born in 1992 so pretty much anyone from 1988-1999) parents, we earn 20% less on average.

home3

Source: Trading Economics

You can see that the marginal weekly increases in wages over the last 16 or so years have been in constant decline. We have not been above 4% since 2010.

This is where a slight bitterness comes in, since it is the baby boomers (those born just after the war) and our parents who have kind of gotten us into this situation (more so the baby boomers though)! Now if we combine that with rising house prices, do we really stand a chance of getting onto the ladder.

So what can be done about this problem?

Many say that building more houses will fix the issue. This is merely my opinion, but this is not a long term solution. What needs to be done is for global central banks to re-assess their strategies of programmes such as Quantitative Easing and increase their respective base rates. By increasing the base rate, you are simply increasing the cost of investment by restricting the supply of credit. You may say this is a very bad idea since growth is still quite low, but I think that has been equally as bad is the no interest rate policy that has been followed post 2008, where the majority of people have not been able to save while cheap money has been given to the ‘haves’.

Alternatively, (and this is going against my free-market conditioning) we could introduce a land value tax. So for example, if the need for housing is greater in some areas vs others, we can apply larger taxes on the land owners who wish to use the land for other gains. The key here is ‘land owners’ and not land occupiers. This deters the building of say a shopping centre in an area where you could build 300 houses instead. How this could work well in London is levying higher taxes on foreign investors who use property merely as a ‘bank account’ and do not live there. As mentioned before – close the gap on the yearly appreciation by levying a higher tax on purchase.

We must remember that this housing issue is not just a UK problem. Scandinavian cities, Vancouver, Toronto, San Francisco, New York, Hong Kong, Singapore, Tokyo are all experiencing the same problems. When you see such a correlation, you have to begin to wonder as to what is causing it, and since most central banks in the developed world have been following the same monetary policy process, or are highly interdependent on each other’s economy, some bells have to start ringing.

Follow me on Twitter @DavidBelleFX and check out my blog www.davidbellefx.com for economic opinion, market commentary and trade calls.

Thanks for reading.

 

A question I was asked on Twitter

From @ijbarratt: what are the biggest changes you see coming in the following years and how do you plan to capitalise?

Pretty broad question. Cheers Izaac.

I think one of the biggest things we’ll start to see is decentralisation of processes. We’ve already seen the rise of the crypto-currencies and online marketplaces such as Silkroad which use Bitcoin to make transactions with since it is anonymous. Blockchain is a ledger process that is still heavily in its infancy, but I feel that there is definitely some place for it. Even investment banks are really starting to adopt the technology.

All transactions have an auditable trail and a traceable digital fingerprint. The data on the ledger is pervasive and persistent, creating a reliable “transaction cloud” where transaction data cannot be lost.

Another key difference between distributed ledger and traditional database technology is how they approach security. Distributed ledgers encrypt individual transactions or messages in the data stored on the blockchain, whereas traditional databases typically have a database-wide layer of security that, once breached, offers access to all of the data inside. In a world where the threats of hacking, data manipulation and compromised data are very real, the security and risk management implications of these two different approaches are important considerations.

The above is key for the future of keeping transaction, audit and costs from cyber crime low. In addition, because it isn’t centralised, if one ‘node’ is compromised then you can still gain access to the rest of the database with no issues.

I don’t know a huge amount about the technicalities, but it looks like it could be a major development. https://2030.io/ is a great community to learn more about it. How I’d capitalise? That is TBC.

The second change I see happening is a real push from ‘Internet of Things’ manufacturers. Someone only informed me that it was a real industry used phrase a few weeks ago. These are goods that are connected to the internet and which act intelligently i.e you can turn lights on or your heating with an iPhone app. Eventually I think that’s how our houses will be operating. You might have forgotten to turn a light off before you go to work, but you can then turn it off with your phone, saving a bit of cash. Or you won’t ever need a door key again, just your phone, a password and fingerprint.

The third change that may take a decade or so to proliferate is the US student loans crisis. I can foresee a load of defaults happening, since student loans and car loans are the only two markets post financial crisis where deleveraging hadn’t occurred. I’ve written about that here.

Lastly, I see a continued growth in app companies – Snapchat, Uber, Deliveroo etc. Massive valuations, no product at all, but provide a useful and needed service.

I don’t really like predictions because you live in dreamland with those, but that is what I could see happening.

Is Trump totally mental to dismantle Dodd-Frank?

Image result for dodd frank

Dodd Frank was introduced after the financial crisis to prevent excessive and dangerous banking practices that partly caused the 2008 meltdown and the requirement of taxpayers to bail out large investment banks and other institutions.

I think to answer the above question, the mechanism by which the 2008 crash occurred must be explained. Here is a very simple note on why it happened. 

I won’t go through all of the terms of the legislature because there are so many, and quite frankly, I don’t have the relevant experience to comment on some parts of it, but the parts that I do understand I will do my best to explain and evaluate.

In short, Dodd Frank is there to increase moral hazard on banks to protect the end consumer.

Moral Hazard – lack of incentive to guard against risk where one is protected from its consequences, e.g. by insurance.

Banks were deemed too big to fail. They knew that the taxpayer would have to bail them out. Dodd Frank’s introduction makes them more susceptible (in theory, but I’ll come onto this later) to accountability. The introduction of The Financial Stability Oversight Council and Orderly Liquidation Authority and Consumer Financial Protection Bureau 1) force banks to increase capital base (increase liquidity) if they are deemed to hold too much systematic risk and also break up banks for the same reason (ha, as if that would ever happen) and 2) the CFPB prevents mortgage brokers from earning high commissions via predatory practices (giving out subprime mortgages like they’re sweets) whereby they earn higher interest payments but the assets end up having a higher default risk.

What could Trump possibly benefit from by deregulating these areas? Well, he has quite a few ex Goldman executives around him. He has some of the biggest tech firms and conglomerates on his advisory team. These firms need access to capital and credit. Trump is a believer in trickle down economics (stupidly) whereby firms who provide jobs will eventually have their wealth trickle down to the workforce that they have created jobs for. This is absolute rubbish and has been proven not to work – look at the increasing disparity between executive pay and lowest paid workers in the majority of large firms.

The issue here is that repealing Dodd-Frank may mean rejecting the accountability measure that should be placed on banks when dealing with a product such as mortgage backed securities where everyone who owns a home or is renting from a landlord can be affected when they are traded – or when the system fails.

I think there has been too much emphasis placed on Dodd-Frank being the main development in banking regulation and process, however. Basel III has been a far greater and more far reaching introduction. Whether you want to attribute the following to Dodd-Frank or Basell III is negligible, because all that is really apparent about the following quote is that systematically, the risk is essentially the same if not subjectively worse:

Just how much has bank capital increased since the passage of Dodd-Frank?  It all depends on what you mean by capital.  According to the FDIC, at the end of 2015, commercial banks had “total equity capital” of $1.8 trillion.  This is certainly higher than the $1.5 trillion that existed at the time of Dodd-Frank’s passage.  But bank assets also increased.  What matters is the ratio of bank capital to total bank assets.  At the passage of Dodd-Frank that ratio was 11.1.  At year-end 2015, it was 11.2.

Some apparent increases in bank capital relative to risk-weighted assets are due to the fact that banks have massively shifted into low risk-weight assets.  Under a system of risk weighted capital, the required capital is a function of the target capital level times the risk weight of the volume of the asset.  For example whole mortgages have historically had a risk weight of 50%.  So if one holds $100 million in whole mortgages and the target capital is 8%, then actual capital is not $8 million but rather $4 million (8 x 0.5).  Needless to say the risk weights have come under considerable scrutiny, especially since assets like Greek government debt were given risk weights of zero.

Since Dodd-Frank, commercial banks have more than doubled their holdings of U.S. Treasuries, which require zero capital.  Banks have also increased their holdings of mortgage-backed securities and municipal debt, which also have low risk weights.  The point is that banks haven’t really raised lots of new capital as much as they’ve gamed the risk-weights to appear to have more capital.

https://www.alt-m.org/2016/03/18/did-dodd-frank-increase-bank-capital/

So the argument that repealing Dodd-Frank based on reducing systematic risk actually vanishes pretty quickly, since nothing has really changed when looking at the books. I would argue it has actually been made worse, except the introduction of Dodd Frank has simply allowed a veneer of respectability and accountability to be placed onto banks.

If this is the case, then Dodd Frank is merely protecting consumers via bureaucracy – which in this case isn’t necessarily bad. I would argue that the necessity to prevent practices such as being able to buy naked credit default swaps on failing assets while selling that failing asset to someone else (imagine being able to buy insurance on your neighbour’s house, setting fire to it, then collecting the insurance money – Goldman were doing that with collateralised debt obligations), which only Europe have done is necessary. Increasing pre and post trade transparency and reporting on bank risk is vital to be able to monitor systematic risk.

But let’s think of this. Has Dodd-Frank prevented Deutsche Bank or Santander from repeatedly failing stress tests in the US? Nope.

I think that repealing Dodd Frank won’t make much of a difference to systematic risk at all by looking at the last paragraph of the quote. So Trump is a madman, but this isn’t really a time which is going to absolutely wreck the world.

Oil, Gold, USD, GBP, Yen COT report breakdowns & interpretation #fx #oott

 

We are seeing a 5Y extreme net bullish positioning from non commercial speculators. I would want to see bids at $40-46 forced out first, however. This means that a drop of about $13 is available. We have a slight Wyckoff bottoming pattern. I remain bullish above $36 long term on oil (WTI).

Gold

Looking at PA and the reduction in longs over Q4 2016 indicates that we aren’t in for a bull run any time soon. Wyckoffian schematics indicate a move to $1,050. Currently hitting a rounded resistance retest of a key low volume break below support, I would continue shorting gold with a stop above $1,260, target of $1,050 for a 3:1 risk to reward trade.

USD

Dollar longs have remained stable over the past few months. Open interest had increased due to the Trump USD rally. Trump’s team has said the dollar is too high very recently. External to this, USD LIBOR rising could be causing investors to shy away from USD denominated assets over the next few months as dollar hedging costs become too great relative to potential yields. I’d expect the dollar to stay within current ranges of 96-104 for the foreseeable future, however longer term I still remain bearish. What could change this is a) NAFTA terms being reassessed b) changing geopolitical situations c) Trump does something even more mental that has longer term economic implications.

Sterling

Sterling shorts have been covered since November. This is most interesting to me due to the perceived general public fear over a GBP crash when Article 50 is triggered. This could suggest that in reality, sterling would be in for a rally if you want to look at recent sentiment regarding the pound. We’ve had a pretty large spike in bearish volume at lows back before Christmas. A spike in volume at relative lows or highs can sometimes indicate a reversal, but I wouldn’t put too much credence into that. The ‘fat finger’ low at 1.1945 has not been taken, however I am basing my stucture off of the lows at 1.21 and 1.20. A hold above 1.20 I will remain bullish, however I expect a ranging market where sellers will be absorbed over the next few months.

Yen

Similar PA to gold here (understandably). Non-comms are net short Yen. How long they’ll maintain this for is another question if we start experiencing risk offish behaviour in other assets. Yen on a longer term picture is more interesting –

Below 0.80 and we could see 0.70. If 0.80 holds, however, Yen bid is on, even if this is totally detrimental to the BoJ’s aims.

Trump and May Set to meet

Today’s “off the wall” (pun intended) trade idea? – buy avocado futures! (More on Mexico below)

Later today President Trump and U.K. Prime Minister Theresa May will meet in Washington.

There will be a press conference following the meeting at which Trump is sure to praise and encourage the U.K.’s efforts over Brexit. He is also likely to take the opportunity to bash the EU much to the chagrin of Merkel, Junker et al.

Yesterday saw the release of Q4 GDP data in the U.K which showed that the inflationary effect of the weaker pound and a perceived slowdown in consumer spending is yet to have any effect on growth.

Sterling continues its recovery. Its performance since the Brexit vote could be characterized as “taking the lift down and is taking the stairs back up!”

The pound has recovered 5% of the “flash crash” Brexit fall against the dollar and continues to be steady against the Euro.

Next week sees “Super Thursday in the U.K. when the Bank of England will issue its Quarterly Inflation Report and the MPC will make its decision on interest rates. Bank of England Governor Mark Carney has already stated that the Bank are watchful and will act pre-emptively should inflation start to increase “outside the normal cycle”.

Mar. Carney has already announced his intention to leave his position in June 2019. Whilst he hasn’t, as yet, taken on the almost mythical status of a Greenspan or Bernanke he was certainly the right man in the right place to steer than Bank of England into calmer waters following the debt crisis.

It is to be hoped that his successor is already being groomed with the departure coming at a critical juncture in Brexit. The U.K. will need to be careful not to become “Manchester United after the departure of Sir Alex Ferguson!”

Later today (1.30GMT) sees the release of Q4 GDP data in the U.S.

This is expected to see a healthy increase from 1.4% in Q3 to 2.1%. Economic activity continues to pick up in the U.S. Jobless figures are at the level which equate to “full employment” below 5%.  The dollar index has fallen (slightly) every week since the turn of the year and we could see the uptrend recommence should this data surprise at all to the upside.

President Trump has done pretty much all he can other than to “invoke the Spirit of the Alamo” upset Mexico over the past week or so. It seems the wall will be built but the question remains “who will pay for it?

80% of Mexico’s exports are to the United States. America has an eighty billion dollar trade deficit with Mexico. To a certain extent, they need each other but the onus is on Mexico as President Trump is well aware!

A 20% tax on Mexican imports is a double edged sword. It will pass the burden onto the U.S. consumer but could also drive importers of Mexican goods to look elsewhere to source product.

 

 

Looking to reduce international payment costs?

I’m currently working in partnership with www.currencytransfer.com (until we get our firm off the ground) and I’d love to hear from you.

Whether you’re an SME or a large corporate, Currency Transfer is able to offer bank beating rates and decrease costs by 1-5%, which over the course of one year would most definitely add up as you can imagine.

Here is an image of how easy it is to make a bank beating currency transfer:

  1. Simply enter the amount you wish to send in the currency of your choosing

2. Then enter the delivery date (date the transfer is to be made) and reason for transfer.

3. Then simply click ‘get quote’ and click ‘book’ to confirm your transfer!

 

It really is that simple. Additionally with this platform, you are able to make one block trade and then divide the amount sent into different bank accounts (if you are paying overseas wages for example). This can save a lot of admin time on the other end.

Send me over an email now for more information: dbelle@davidbellefx.com

Alternatively, if you are happy, then you can start saving today by clicking here and opening an account.

 

Why Are Economists Wrong?

Andy Haldane has recently come out to apologise about the forecasts the Bank of England and experts had made in the wake of the EU Referendum. After having missed the occurrence of the 2008 financial crisis and totally misjudged the Brexit vote, is the Bank in disrepute?

Claims made by leading economic thinkers include statements of ‘fact’ (when it comes to experts providing opinion, the average Joe Public will take this as fact) such as:

“Britain’s shock vote to leave the EU has unleashed a wave of economic and political uncertainty that likely will drive the UK into recession,” Samuel Tombs, Pantheon Macroeconomics.

David Owen, the chief European economist at Jefferies International, said a technical recession – two consecutive quarters of contraction – may now be a given, followed by a period of very slow growth. He also said the UK’s long-term economic potential, known as trend growth, would be lower, “which has to impact the valuation of assets, particularly equities”.

(Guardian, 24th June 2016)

George Osbourne tweeted:

…as a result of Mark Carney’s presser which can be seen here, where they also expected a 20pc fall in the pound, which, by the way, was totally not unexpected – you can read about this in an article I wrote a month or two ago. In actuality, post referendum, we are experiencing very good economic conditions. Business confidence is up in Q4 2016 vs Q3 2016, inflation is at the highest level in 2 years (yet Andy Haldane is now arguing that inflation is going to hurt British consumers, after being a dove for a long time – talk about flip flopping), one of the biggest industries, construction, is seeing a boom, even in the face of higher material costs for builders, and finally, UK Q4 growth was better than expected.

This isn’t meant to be a total critique specifically of the post referendum expectations from the Bank and many expert economists, but a critique of forecasting of many events by economists, as well as their decision making along the line.

Consistently through history, economists have misjudged or mis-forecasted events, from the Great Depression, to Reagan’s ‘Trickle-down economics’, which many still feel holds weight today, to the predicting the financial crisis of 2008.

In 1999, The Economist wrote to the UK’s leading academic practitioners of the dismal science to find out whether it would be in our national economic interest to join the euro by 2004. Of the 165 who replied, 65 per cent said that it would. Even more depressingly, 73 per cent of those who actually specialised in the economics of the EU and of monetary union thought we should join – the experts among the experts were the most wrong.

(The Telegraph, August 2016)

I believe that it is because although economists use varying models, these models are consistently going to be outdated where human behaviours change according to environmental, technological, financial and resource bases advances and evolution. Models used 70/80 years ago are still being used today. A model that worked in a post war world doesn’t necessarily work today. It could lead you to ask why have interest rates consistently been on a decline for 30 years? Why are real wages decreasing long term? Evidently something is wrong with our economic system and I believe that a key reason for this is the lack of credible forecasting from our central banks and government economists, as well as other variables such as increasing inequality, which I think can also be attributed to certain post war mechanisms (hint, baby boomer created mechanisms).

In trading, you can argue that an analyst can have a totally different view of the market to a trader. The issue is that one is well, analysing, and one is actually putting their balls on the line and aiding price discovery – and everything is based on price discovery or supply and demand equilibrium. What is the punishment for Andy Haldane saying that there is the ‘potential’ for a post referendum recession apart from having to make an apology? Not much apart from a red face and an article critiquing him by an MT4 FX trader. A trader would lose or gain. There is something on the line but this leads me onto something that I feel economists totally forget about markets.

Pricing in is the notion that the market discounts everything. The price you view now is the price of all information known in the market. For example, one could look at the dollar rally we experienced from late summer to the December rate hike and consider the high of 118.5 as that being the market including all information based on the belief that a hike would have occurred, since we are now trading 200-250 ticks off of that price. The dollar tends to fall after US rate hikes anyway for about 6 months after. Slight tangent there, but the point is that economists tend to miss this a lot. Traders do not. A 15% fall in GBP was predicted by the IMF a year before Brexit. Traders knew this – they’d been shorting cable from $2.00 highs. They were just waiting for a catalyst to be able to capitalise on that fall – and in my opinion, it would have occurred anyway over time.

It’s the same with the Trump vote. There were heavy predictions of a stock market crash… we are hitting all time highs on Dow and SP500, and we can see the same phenomenon among economists working. In both cases, we saw economists over-estimate the effect of negative events and totally underestimate the effects of anything positive that could be taken from these two political decisions. To be honest, I was guilty of this on Trump. I thought he would win, but I did not expect there to be such strong risk on behaviour in bonds and equities. Conversely, we saw the opposite occur with the 2008 financial crisis. There were probably mutterings of ‘it’s housing, how can that go wrong’? Well in this case, the negatives were discounted totally. Part of this was due to ratings agencies providing smoke and mirrors to the actual situation, and part of this was due to the belief that if anything did go wrong, it would be so staggeringly bad that it just… couldn’t happen.

We also have the issue of data being provided sometimes 3 months too late (inflation forecasts for example). Economies are sensitive ecosystems. Supply and demand shocks can occur and change things very quickly during those periods. However, this is where I feel a more market analyst based approach has to be taken by economists rather than simply always adhering to macroeconomic models – humans aren’t rational beings all the time in relation to economics shocks, and the data lags don’t always reflect this. For example, I found it strange that the BoE cut rates by 25 BP back in August. You could say it was because they were trying to be accomodative, but then you have Andy Haldane coming out with statements that there are inflation risks, when we all know that monetary policy takes 12 months to take effect (however I think that just shows the Bank’s lack of forecasting ability and we go back in circles again).

One thing that I think that certain economists are really understating is the effect that China blowing up will have. Balls on the line, January 2018 that credit bubble will go boom (I can edit this if it happens in Feb).