At the risk of stating the obvious, the GBP (£) has not been doing well lately. With Boris Johnson becoming Prime Minister, the chances of a hard Brexit have increased, and consequently the Pound has suffered.
The GBP to USD – one year history
You might be asking yourself if this is the right time to buy GBP.
It’s a difficult question because there are a lot of factors driving the value of the Pound over the short, medium, and long term. With all the short term Brexit noise, it’s difficult to see the forest for the trees.
At ClearMacro we believe in looking past the noise, and looking at what the underlying data is objectively telling us about projected future returns. This decreases the chance that we make biased investment decisions. But quality data is difficult and expensive to get hold of, and once you have it, you still have to extract the return insights in a sensible, and coherent, manner.
To solve these challenges we created our investment analytics platform, the ClearENGINE™, to transform quality data into forward-looking investment signals.
We recently had a look at ClearENGINE’s signals to see if this is a good time to invest in GBP, or if we should hold off.
What did we find?
Somewhat unsurprisingly the ClearENGINE™ is still bearish on GBP over the short term. We have many signals suggesting that the short term outlook will be negative, and we have highlighted two of them below for illustrative purposes.
The first is our Data Surprise signal, which remains very weak. This signal measures the degree to which economic analysts under- or over-estimate the economic outlook. Lower scores reflect weaker surprises and are inferred to be bad for currencies.
And this is mirrored by the Nowcasting GDP signal, which is designed to provide an accurate estimate of current quarter GDP. Lower scores indicate that ‘Nowcasted’ growth is weak, which is negative for currencies.
After looking at the short term, we moved on to the long term outlook. We wanted to determine if GBP had sold off enough to offer good value over the long term.
What we found is that even though the ClearENGINE™ says that from a pure valuation perspective the currency looks (somewhat) attractive, this is offset by a negative outlook for long term growth and income factors.
What do we mean by this?
The ClearENGINE’s long term return estimate for currencies is built from three factors:
The value component for Sterling projects that the annualized future return will be 1.21% going forward, however this is offset by a projected annualized decrease of -1.36% coming from the income component, and an annualized decrease of -1.06% coming from the growth component.
This adds up to a negative annualized excess return to the forwards (hedging cost option) of -1.31%.
What does this mean in practice?
We are looking at this from the perspective of a USD based investor; the ClearENGINE™ estimates that if you hold GBP outright it will give you an annualized loss of -1.31% compared to the forwards, hence you are better off hedging your GBP exposure. In order for the estimated return to become positive, GBP needs to sell off more.
In summary, we were not surprised to see that the shorter term outlook for GBP is negative. But what we were more interested in determining was if the Pound had sold off enough to offer good value over the longer term. What we found was that from a valuation perspective, it offers some value, however this was offset by other long term factors (growth and income). GBP will therefore have to sell off more before it becomes attractive.