21 comments on “Sigh

  1. Surely causally it is “The FTSE 100 has fallen (because the pound is bouncing back)”?

    Or equivalently “The pound is bouncing back (and so the FTSE 100 has fallen)”

  2. Nah. The prospect of a rise in interest rates has raised the pound and reduced the FTSE 100.

    Or anything else reasonable you care to suggest, since correlation need not imply cause.

    How about: “Noise on signals; pound up, FTSE down”?

  3. @Dearieme

    But it isn’t mere correlation being used to incorrectly infer a cause, it is basic economics – bunch of firms make most of their revenues and profits in foreign currency, what happens to their discounted cash flow *valued in pounds* when the pound rises against a basket of foreign currencies?

    Saying that the pound has risen in value against the dollar, immediately tells us that cash flows in dollars are no longer worth so many pounds. This effect is simply baked in. In a simpler form it’s familiar to anyone who holds eg a US stock index tracker in a UK ISA – you can’t see what happened to the value of your holdings overnight just by checking the closing price of the relevant US index, you have to check the exchange rate too. People with significant overseas investments in their portfolios but whose daily lives are priced in pounds did very very well out of the fall in the pound, less well out of its rise…. and the same logic largely applies to the FTSE, bearing in mind the countries and currencies the firms you’re investing in operate.

    What Timmy is complaining about is the “but” in the original piece. It suggests a contradiction or surprise that the FTSE and pound might move in opposite directions. Which would be naive – there is a component in changes to the value of the FTSE which simply represents the direct effect of changes in the exchange rate on the value of foreign currency cash flows, and it does not move in the direction that “but” is suggesting. Obviously there are other effects that operate on both FTSE and FX so the correlation isn’t perfect. I think where you’re right on the causality/explanatory issue is that for this effect to be the only one needed to account for the movement of the FTSE, then the other effects would need, by chance, to cancel out. But to say it’s all just noise or to deny that there’s any causal component at all seems to me to be going too far.

    Could somebody better informed than me attempt sticking a figure on what % change would be expected in the FTSE purely from the “valuing foreign cash flows” effect of a 1% change in the value of the pound?

  4. MBE;

    Quick hack; calculate the beta (Excel SLOPE) of the index returns to FX returns.

    Slightly longer : calculate the beta of each stock return to fx returns, multiply each by the index weight.

    Longer still; for each index component, split revenues according to currency, adjust for capital structure, get bored, go down pub.

  5. Surely the direction is the other way:

    “The FTSE 100 has fallen because the pound is bouncing back”

  6. Exactly right Tim! You want to know what is funny (terrifying?) – I’ve seen The Wall Street Journal make the exact same mistake.

  7. Can anyone demonstrate that it has never happened that the pound going up has been accompanied by the FTSE going up? Because if you can’t all this explanation is garbage. In complicated systems stuff happens and usually nobody knows why. Post hoc rationalisation is usually just so much wind and piss.

    We know less than we pretend to – as Hayek was wont to point out.

  8. dearieme;

    Of course not; there are way too many variables (sources of risk) for it to be that simple. But in the absence of other factors, company or sector specific, you’d expect the aggregate market indicator to be sensitive to changes in external conditions, whether it be interest rates, fx or oil prices. And you can take a stab at calculating what those sensitivities might be expected to be.

    But the media, generally (and individuals as well), has a tendency to produce simple explanations, so you can get instances where the media say “the FTSE rose on the back of strong oil prices” and the very next day, or even the same day, say “the FTSE fell on the back of strong oil prices”. Both can be true. But for different reasons.

    It’s the rationalisation that’s the problem.

  9. There was a lad from the City on the box this morning explaining that – given what was going on in the world/Brexit, etc. – the human rationale was to sell Sterling. However, because currency trading is ruled by algorithms, the opposite happened. Apparently algorithms know better than humans.

  10. Dearieme – yes, I can demonstrate that. I’ve been keeping the charts for years. To see them, just remit £250.

  11. I’m sure that an equation of the form r(FTSE) = A + B*r(change in USD value of GBP) would have a negative value for B if estimated on daily returns. Though of course there will have been many days when both FTSE and sterling have risen.
    And over longer periods the cumulative positive effect of A will (or at least has) overwhelm B whatever the sterling trend.

  12. All else equal, if sterling moves one way then ftse 100 goes the other way. That’s due to ftse 100 having majority of earning not in sterling.

    But that doesn’t mean that if sterling moves one way, ftse 100 goes the other. So the headline could be right if it was ‘sterling rises but ftse 100 falls because xyz’

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