The new bull market in sterling is just beginning

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Just after midnight on 7 October, 2016, sterling slipped to $1.14 in the so-called “flash crash”.

The pound is the oldest currency in the world. Bar a few days in early 1985, this was the lowest level it had ever sunk to.

The political uncertainty which followed the Brexit vote had spooked the currency markets.

Things are looking rather different now.

The dollar is weak – but the pound is also strong

Today the pound is at $1.40. From low to high that would make this a 20% rally in the pound since October 2016 – for a currency, that is no small beer.

In 2018 so far, the pound has even outperformed bitcoin! (Mind you bitcoin is currently in a bear market, so the comparison is not fair.)

Much of these gains have been, quite simply, because the US dollar has been so weak.

One of President Trump’s stated aims was a weak dollar. In that, he has been successful. Tuesday 3 January, 2017, marked the high in the US dollar index (that’s the US dollar versus a basket of the currencies of its major trading partners). It was the strongest the dollar had been in the 15 years since 2002.

The dollar has been falling ever since, which is one of the reasons asset prices – particularly stocks – in the US have been doing so well. Quality assets and a cheap currency attract capital, and so international capital has flowed to the US.

But the pound’s strength has not just been a function of US dollar weakness. Since Theresa May’s election “mix-up” (which brought uncertainty and pound weakness) of last summer, the pound has been rallying against the Aussie dollar, the Canadian dollar, the New Zealand dollar, and the Singapore dollar.

It’s also been strong against the Japanese yen, against the euro and against both the Swedish krona and Norwegian krone. It’s been strong against just about everything – because this is a bull market.

Even Mark Carney and the Bank of England haven’t been able to talk it down – and that’s saying something.

The question we must now ask is – how much further can it go?

Sterling is still in the foothills of this bull market

On a short-term basis – and by that I mean over the next few weeks – I would not be surprised to see a small pullback and some consolidation. On a longer-term basis, I remain bullish.

Bull markets often begin from oversold levels – when an asset is too cheap. Think gold at $250 an ounce in 2001; think US stocks with the S&P 500 at 666 in 2009. First they go through a phase where nobody believes it – and so the majority stay out. Eventually, they reach fair value. And finally there’s exuberance, when everybody jumps on board for fear of missing out.

Gold reached the exuberance phase in 2011. Bitcoin reached it late last year. US stocks are somewhere in the exuberance stage now (and that doesn’t mean they can’t still go a lot higher).

Sterling reached the opposite of that stage in October 2016. It was doomed. “Buy, buy, buy” I said and, oh, how they mocked me.

Though people are slowly coming round, I’d say that now sterling is still is somewhere late in the “nobody believes it” phase – or perhaps “few believe it” is a better way of putting it. Though there are many who believe and have always said that Brexit will be good for the economy, many others – and particularly the media – still seem to think it is a disaster.

Every time there is good economic news, the phrase “despite Brexit” still appears. That unemployment is low, growth is good, stocks are strong, investment is running high – and sterling is rising – doesn’t seem to matter.

It’s not even fair value yet. On a purchasing power parity (PPP) basis, sterling is also undervalued. Analyst Charles Ekins of Ekins Guinness calculates the relative PPP of currencies based on relative inflation, which is similar in principle but not the same as measuring the prices of a relative basket of goods.

Ekins calculates that fair value for sterling against the dollar is $1.60 (versus the current price of $1.40). Against the euro it is €1.20 (compared to the current price of €1.13). Thus sterling, even after its run, remains undervalued against both, albeit not by as much as it was.

What few seem to have considered is that sterling could not only reach fair value, but exceed it. That is what happens in bull markets.

Here’s what could drive sterling a lot higher – maybe even to $2

We are still many years from this, of course. But there are all sorts of things, which could continue to move sterling higher.

First, of course, there’s the economy. The general mood is that the economy is doing well at the moment. It could continue to do well. It may even be that leaving the EU leads to an economic boom. We continue to stumble our way through the divorce without too much harm done. We secure all the trade deals we want outside the EU, and they’re good deals. Trade and exchange increase. Overseas investment piles in. Britain thrives. Unhampered by EU regulation, Britain outperforms its neighbours. The economy expands. It’s all possible.

Second, we get a good prime minister. If there’s one thing that characterises Theresa May, it’s that, like the hardiest of cockroaches, she is a survivor. She’s not popular; she lacks the common touch; she seems unable to offer any opinion about anything. This lack of apparent clarity means that every time she has to do anything – an election, a cabinet reshuffle – there’s no guiding philosophy and thus incompetence always raises its head. But she’s still there.

But the word is she does not particularly want to be there. It is only the lack of clear alternatives that is keeping her there. I doubt she’ll be allowed to run another election and it’s not beyond the realms of possibility that she stands down before and a new leader of the Tory party is elected.

Say Corbyn-mania also proves to be a passing fad. The new leader wins the next election with a strong majority and we actually do get a “strong and stable” government. We don’t have one at the moment. If we did, that too would be extremely sterling bullish.

Finally, there are rising rates. The Bank of England base rate is still 0.5% – an extraordinarily low number when looked at in a historical context. It is possible that the interest rate cycle has bottomed, and that rates creep up from here. (In the US, ten-year yields just hit three-and-a-half-year highs).

Heck, even Carney might put them up. But he is set to leave in June 2019. What if the next governor wants to return us to monetary normality?

Higher rates – assuming they are not driven up by some financial panic – would also be good for the pound.

But these triggers are all long-term boosters that are some years off. For now we remain in the “few believe it” phase.

Regular readers will know I’ve been calling a bull market in sterling for some time now. Based on Frisby’s Flux (the eight-year cycle in the pound), I’m looking for a high somewhere around 2022-23.

By then, who knows where the pound will be. It may sound ridiculous, but I would not rule out $2. We’ve been there before. If this bull market properly takes off, we could eventually get there again.

  • Cameron Holder

    There are parts of this article that just aren’t true.

    “It’s also been strong against the Japanese yen, against the euro” – GBP was at about €1.18 a year ago, it’s weaker at €1.14 now

    ” The general mood is that the economy is doing well at the moment.” – The UK economy is anemic at the moment and the IMF singled the UK out as the only major part of the global economy that isn’t performing.

    • Stephen Buckland

      Also, “strong against the Euro”, on what measure is 1.141 strong???

    • Aldo

      “There are parts of this article that just aren’t true.” Absolutely agree, Cameron Holder, and not only this article: there’s so much Brexidiot propaganda from MoneyWeek generally together with pro-Trump nonsense, promoting the right-wing populists fantasy race to the bottom that shreds all pretency of decency.

      • Horiboyable .

        It’s not populist, the trend in Europe is right. The whole of western Europe is loaded to the gills with sovereign debt and they will default, just like they did in 1931/2. They say history never repeats but quite often it does and it will have been caused by socialism AGAIN. There really is no excuse now we all have the internet. The USSR five year plans did not work, China, Great Leap Forward did not work, Cuba had citizens risking their lives, hanging on to car wrecks in shark infested waters to get Miami and now, Venezuela with the biggest oil reserves in the world have their citizens hunting dogs and cats in the street to eat and no toilet paper.

        Repeating the same actions over and over again and expecting different outcomes is insanity.

        Citizens are dying in corridors in NHS hospitals, our footpaths and roads are falling apart, street lighting is off at night. I remember being able to bring up seven children on one income and now working couples can hardly make ends meet bringing up two children. How many signs do you need to see before you realize we are in the process of collapse now.

        You do not just wake up one day and observe that your country collapsed last night, its a process and it began back in 2008 maybe 2000. It can happen quite quickly to like Rome went from about 1 mil citizens to 50 to 70k in a decade and Venezuela since 2013. We can still borrow money at the moment but sooner or later no one will bid on our GILTS.

        My bet is a black swan in the Eurozone and capital will flee into the dollar sending it so high it will break most currencies. Japan could cause a back swan as well. Get yourself a helmet because this ride will get rough.

        • Aldo

          We saw how the trend in Europe was ‘right’ in the 1920s & 1930s, saw also how that ended. Disagree WW2 was caused by socialism, unless you mean its populist, nationalistic version! Not that I’m promoting socialism either, but if history repeats, that’s just what the populist neo-fascists are doing, and we both agree repeating the same actions over and over again and expecting different outcomes is insanity.

          Given current American divisions, inequalities, debt & vicious insularity, a black swan is as likely to collapse the $ as to send it so high to break most currencies.

          • Horiboyable .

            The dollar will not collapse yet, its the only currency in town at the moment. The next economic center will be China but they are not ready for prime time because their markets are not deep enough to park big money.

            What is coming is an economic event that could cause war and civil disturbance, its unavoidable. When folks are fat and happy, they do not want to fight. But when people are losing and they have nothing else to lose, they lose it.

    • LeMonsieur

      “Since Theresa May’s election “mix-up” (which brought uncertainty and pound weakness) of last summer,” it has been strong

  • Timothy Stroud

    Good piece which I largely agree with. The US economy is booming and will
    carry on booming, leading to Trump’s re-election in 2020. The UK economy is
    probably doing much better than gloomy government statistics pretend.
    The new app economy cannot be measured with any certainty, and the
    government does not really know what is going on in the app / cash / black
    economy. Corbyn is a dud, and it is quite likely various Labour MP’s will resign
    this year. ditch the Labour whip, and start another SDP Mark 2.

  • Leitmotif

    If you look at PPP with regards Germany/France particularly property £ is worth about 0.5 Euro. Couple of little anecdotal examples very large Black Label whiskey (3 measures) – Spain less than £3 UK about £10. Germany Lido – about £2 UK £6.

    The UK has enormous property megabubble and trade deficit, burgeoning welfare state (even compared to W Europe – that’s why they are queueing up at Calais).

    Long term £ at least v Euro is going down

  • ExpatZ

    Fake news.
    The Dollar is DROPPING, had the Pound risen against BOTH the Dollar and
    the Euro then you could claim the Pound is strengthening, but it is not.
    The Pound is steady against all other currencies, it is the Dollar the
    Please do take the time to understand how these things really work.

  • LG

    “strong against the Euro”

    Which planet does the author live on?

    • LeMonsieur

      “Since Theresa May’s election “mix-up” (which brought uncertainty and pound weakness) of last summer” the pound has been strong against the euro

  • DiverPhil

    You Just have to admire someone who can earn a living repeating this guff, I am glad its free on line, I wouldn’t want to pay for the hard copy, by this measure.