You’ve heard of Kondratiev waves – now meet the Frisby flux, the pound's eight-year cycle

Dominic Frisby thinks he’s found an eight-year cycle in the pound, which he’s dubbed the ‘Frisby Flux’. Here’s what it is, what it means, and how to trade it.

161027-the-pound-b

As soon as the word cycles' comes up in investing, I breathe out and try and erect a defensive mental wall.

I want as little of that stuff as possible getting into my head. I think I've heard more of the proverbial spouted about cycles than anything else.

Subscribe to MoneyWeek

Become a smarter, better informed investor with MoneyWeek.

It is easy to look back at events, find some arbitrary pattern and declare it a cycle. All of a sudden, you're a cycles expert and you've got a newsletter.

There is the Kondratiev cycle, the 14-year cycle in real estate, the seven-year crash cycle, the commodities super-cycle, the demographics cycle and those are the better ones.

Advertisement
Advertisement - Article continues below

So it is with no little trepidation that I present you with the topic of today's Money Morning I think I've found a cycle

Cycles are easy to spot, but trading them is another matter

Even straightforward-sounding cycles are tricky to trade. Take the four-year "presidential cycle" in US stocks. (I'm aware that GMO's Jeremy Grantham, one of its main proponents, recently said that it doesn't work any more because the US Federal Reserve has broken it, but let's use it for example's sake.)

The idea is that economic sacrifices are made during the first two years of a president's term (while it's still OK to be unpopular). This results in the "four-year cycle low" in the stockmarket. Then, in the final two years of the term, the focus shifts towards stimulus, to boost the economy ahead of the next election.

But how do you trade that? It's fine in hindsight any academic can dig around after the event, find a low in a president's second year of office, then declare: "Look! A cycle!" But knowing that you're seeing a significant high or low as it actually happens is a very different prospect.

Nevertheless, cycles do exist we have the seasons, the moons, the cycle of life and so on. There are good times and bad times. There are bull markets and bear markets.

Mining is very prone to cycles. Tech stocks go through a clear cycle as they evolve. And thinking in terms of cycles does help you to frame the bigger picture: it can give you an idea where you are in the grand scheme of things.

Advertisement
Advertisement - Article continues below

And, guess what? I was look at a long-term chart of the pound the other day and you'll never believe what I've found. A cycle. Yup.

This one lasts eight years. It needs a name. The eight-year cycle in the pound is too dull. How about the Frisby Flux?

Trading the Frisby Flux

With the flash crash a fortnight ago, the pound hit $1.18 according to Bloomberg though some trading houses have it at $1.14. From $1.26 to $1.14 in two minutes. How about that!

While last week, according to the Bank of England, measured against the currencies of Britain's trading partners, the pound sunk to its lowest level ever (or at least since this measure began, which is 1975). Using the $1.18 figure, from the high in 2014 of $1.70, there has been a 30% drop.

In the financial crisis off 2007-09, we got an even bigger drop. $2.11 was the high and $1.36 low, a loss of 35%.

Before that, while the dotcom bubble was noisily bursting, the pound was discreetly going about its own little bear market. From 1999 to 2001, it lost 20% of its value.

Advertisement
Advertisement - Article continues below

Track back eight years to 1992, and we're in Black Wednesday territory, when George Soros and others notoriously sold the pound so hard that the Bank of England was forced to take the UK out of the European Exchange Rate Mechanism. It went from $2 to $1.40 a 30% loss.

Go back another eight years and in 1984-85 we have the all-time low for the pound against the dollar. The miners' strike was in full flight here in the UK, while the US dollar was so strong that the governments of France, West Germany, Japan, the US and the UK all agreed to depreciate the dollar against the Japanese yen and German mark (the Plaza Accord).

This was the biggest drop of the lot. From 1981 to 1984 the pound went from $2.40 almost to parity. The loss was over 55%.

Go back another eight years, and you will find another cycle low in 1976. Then the pound hit $1.60. $1.60 sounds like a lot compared to $1.22 today, but in 1973 the pound was $2.60. So that drop was almost 40%.

Have I convinced you then that there is an eight-year cycle in the pound?

Here's the long-term chart for your perusal.

161027-pound

According to Frisby's Flux, we should then be looking for a low in the pound somewhere between now and next spring. I'm wary about calling the low because I called it at $1.27 was given a decisive slap in the face by Mrs Market.

Advertisement
Advertisement - Article continues below

But the conditions are ripe for a low. We have extreme bearishness, with record short positions in sterling. We have extreme uncertainty. Nobody seems to agree quite how we will leave the EU and under what terms, while there is a movement underfoot to undermine the exit where possible.

Can those extremes get more extreme? Possibly.

But moving forward we know that Bank of England boss Mark Carney will have to end his latest bout of quantitative easing (QE) at some stage, particularly with anti-QE sentiment finally getting some momentum. One should not underestimate the impact that the latest bout of QE and reduction in rates has had on the pound. When it is reversed, it will add strength.

And as we move into spring, the path of Brexit will become clearer. Yesterday I was talking to Peter Lilley MP, who is involved in the negotiations. (I'm speaking tonight at a dinner he's arranging, but our discussion quickly got on to Brexit.) He seems to think the exit is much simpler than the media would currently have you believe. He may be right. The end result, like most things, will, I expect, be worse than hoped and better than feared.

Maybe $1.18 needs to be re-tested, maybe we've already had the low, maybe we will see another leg lower early next year perhaps towards parity. Nobody knows.

But Frisby's Flux says the bear will be over by the spring.

Advertisement

Recommended

Visit/currencies/600640/the-currencies-to-bet-on-this-year
Currencies

The currencies to bet on this year

The US dollar could be set to weaken this year, while the euro, Canadian dollar and the Swiss franc could be good bets for optimistic traders.
17 Jan 2020
Visit/506272/welcome-to-currency-corner-your-weekly-guide-to-the-worlds-biggest-market
Currencies

Welcome to Currency Corner – your weekly guide to the world’s biggest market

Forex is by far and away the biggest market in the world, with an average daily trading volume of over $5trn per day. Here, Dominic Frisby looks at th…
3 May 2019
Visit/502761/the-nature-of-money
Currencies

The nature of money

The best currencies are based on a strong democracy, strong institutions and a firm attachment to both the rule of law and the protection of private p…
28 Feb 2019
Visit/currencies/600665/currency-corner-new-zealand-dollar-kiwi-vs-us-dollar
Currencies

Currency Corner: how is the New Zealand dollar doing against its US counterpart?

The New Zealand dollar has been doing well against the US dollar in recent months, but has started to wobble a little. Is it still a buy? Dominic Fris…
20 Jan 2020

Most Popular

Visit/investments/commodities/gold/600686/gold-and-silver-bull-market-2020
Gold

Want to make money in 2020? Gold and silver are looking like a good bet

If you want to make money from investing, says Dominic Frisby, it’s simple: find a bull market and go long. And in 2020 gold and silver are in a bull …
22 Jan 2020
Visit/economy/600667/money-minute-wednesday-22-january-uk-public-borrowing
Economy

Money Minute Wednesday 22 January: UK public borrowing

Today's Money Minute looks ahead to the latest on of the UK's public finances, with the Office for Budget Responsibility’s forecasts for borrowing thi…
22 Jan 2020
Visit/economy/600690/money-minute-thursday-23-january-european-interest-rates
Economy

Money Minute Thursday 23 January: European interest rates

In today's Money Minute we look ahead to Christine Lagarde's second interest-rate-setting meeting at the European Central Bank.
23 Jan 2020
Visit/investments/stocks-and-shares/share-tips/600653/indias-small-and-mid-cap-stocks-are-set-for-big
Share tips

India’s small and mid-cap stocks are set for big gains – here are three to buy now

Each week, a professional investor tells us where he’d put his money. This week: David Cornell of the India Capital Growth Fund highlights three favou…
20 Jan 2020