Morning:
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A couple of months ago, a pound was worth two dollars. Yesterday, it fell through $1.80. It would be no surprise to me to see it slide to $1.65 before Christmas. Even that, given the way markets work, needs not be the floor.
Remember how, in the early part of Mrs Thatcher's Prime Ministership in 1981, when she lifted exchange controls and North Sea oil started flowing in earnest, the pound soared to $2.40, having been as low as $1.56 five years earlier when the Labour government was forced to get a loan from the IMF? The Tories had little time to be smug. Four years after that $2.40 peak with the oil price receding, the pound sank to what is still its all-time low against the US currency when in 1985 it touched $1.03.
This is not to say the pound should plunge well below $1.65 this time because round about that level is probably fair value in purchasing-power terms. But it is the way markets work particularly now they are electronic. The reliance on computers, algorithms and automatic trading strategies, all of which are now commonplace, has given a huge impetus to momentum investing at the expense of those who buy and sell in the old-fashioned way — by taking a view on the fundamentals.
The theory is that the more trading there is, the more liquid markets become and the more perfect the process of price formation. But, as so often, the theory is rubbish though not yet recognised as such. The reality is that electronic trading makes it harder than ever to stand out against the crowd and still stay solvent. So fewer and fewer try, and there is nothing to temper the violence of the swings in prices.
Once the market establishes a trend, the momentum strategies kick in and the trading becomes one-way. The fluctuations around what should be fair value are ever more extreme. The investment banks pump out “independent” research to justify continuation of the trend — witness what is currently happening in commodities.
This is what we will likely see in currencies, and it is what we have seen in the stock market in shares such as Yell, and are now seeing in oil. There was no reason in logic or in fundamental supply-and-demand terms for oil to go from $80 to $140 in a matter of months. Now it is back down to $110 and will probably drop back towards $80 or $90 as the hot speculative money moves on.
The fall in sterling that we have already seen is throwing up problems for business, as mentioned here yesterday. Of course, it is good for those with high dollar earnings such as Michael Spencer's ICAP, just as in this case it is potentially bad for Terry Smith's Tullett Prebon, seeking to engineer a merger with New York-based rival GFI.
Indeed, one wonders if that deal can still be done, given that when the talks became public a couple of months ago, the pound was at $1.98 and that made Tullett Prebon the bigger business. Now as the talks drag on the American side has become the larger, which implies significant dilution for the British side's shareholders if it is to remain the bidder.
That may not be a deal-breaker, given Terry Smith's legendary negotiating skills, but it certainly makes it a lot more difficult to complete the acquisition and still deliver value.
Times are always hard in business
Richard Roberts, one of Barclays Bank's specialists in the small and medium-sized business sector, was quoted in the Financial Times yesterday as saying that there could well be 150,000 business closures in the next 15 months or so. It sounds a huge number, and it seemed at first glance to confirm the impression that we are about to drop off a cliff, adding more doom and gloom to an already uncertain economic outlook.
But perhaps it is not as bad as it looks. Government statistics say there are an estimated 4.7 million small enterprises of different kinds in the UK — although that does include one-man and one-woman traders such as the local window cleaner. That said, there are just short of three million business bank accounts in the UK — a figure that presumably understates things, given the continuing presence of the black economy — so we are dealing with a large number of enterprises. Against such a total, a failure rate of 150,000 in three million seems not bad at all.
In truth it is probably too low. In normal times — accepting that right now is not normal — huge numbers of small businesses fail after two or three years, and that is true of almost every sector. Even at the top end among hedge funds, it is thought that 40% close within five years. In the magazine business, even before the days of the internet, they used to say that 95% of new launches would not last five years.
It is a fact of life that most good ideas are not good enough, most people would have trouble running a whelk stall and, with all the bureaucracy and form-filling, it can be crushingly hard work. That forecast of business closures does not suggest the economy is heading for recession. But it does confirm that even in normal times running your own business can be very difficult.
