Capitalizing on Brexit – Portfolio changes

As mentioned in my previous post last week, a momentous event like Brexit seems to be too juicy to miss. Over the weekend, I set about trying to find a way to hopefully profit from it.

Fortunately for me, I have just a few weeks earlier, divested my entire stake in Hock Lian Seng and a substantial stake in Metro Holdings, freeing up capital to deploy in turbulent times like this. As mentioned in earlier posts, I’ve also covered my shorts, freeing up yet more capital. It’s been a good black swan event thus far, no complaints.

I am no expert market timer. I did not forsee Brexit. And like many others, there have been many times when I found my capital locked up when there’s panic and it’s time to buy. This time though, luck seems to be on my side.

Over time, I’ve come to realize that aside from intense equity research, portfolio management is another key that’s just as important. In one of his writings, Dr Michael Burry talked about realizing the importance of his portfolio allocation as well. Cash, at the right time, is extremely crucial.

So what did I do?

108) British pound.jpg

Well, the problem is that finding and researching deep value equity takes a long time. Weeks, and in fact, usually months. A single weekend is just not enough. However, a single data caught my attention:

The British pound to US dollar rate hit a 31 year low

Again, I usually steer clear of Fx. I think most people should too. Fx has too many moving parts, too many things that are unpredictable can affect Fx. Of course many people who dabble in it claim to use technical analysis, but since this blog is meant to be mostly deep value oriented, we’ll not talk about that here.

So I’m no Fx expert either. But I do know that there are not many things that are at 31 year lows. I did a bit of research and I can’t find data on GBP-USD that goes back that far, so I’ll just have to take the word of the article that I read. The data that I found does confirm that the exchange rate is the lowest BY FAR in the past 12 years.

Since there’s no FA to talk about when it comes to currency, I’d have to rely on some global macro research and a healthy dose of common sense.

So why did the GBP fall so drastically, so quickly?

This seems like a common sense thing. Britain left EU, of course it’s currency suffered. But then again, why? As I thought deeper, it’s not exactly a simple question after all.

109) notes-1199516__180.jpg

The most obvious reason would be that Britain has lost it’s much vaulted AAA credit ratings. (This doesn’t quite make sense to me, since upon leaving the EU, Britain actually has even MORE control over it’s currency. They aren’t going to default on government debt, why default when you can print more pounds and inflate your way out of it)

Another reason could be panic. People selling the pound to buy the traditional safe haven currencies, particularly the USD and the yen.

One analyst report that I read also pointed out that Britain has a large current account deficit, and this deficit is currently masked by large inflows of foreign capital. If these investors panic and pull out their investments, the pound’s value will drop further.

Finally, the last argument I’ve read is that demand for British goods and services will fall as EU puts up barriers or reins. This in itself, leads to lower demands for GBP.

These are mostly valid arguments. Still, a 31yr low! That’s something that plays in my mind. So let me dissect these arguments:

AAA credit rating. Well, right now the BOE interest rate is 0.5%. There isn’t much room for it to go any lower. I don’t pay much attention to the credit rating since the rating agencies have proven a propensity to get things wrong. The interest rate would more directly impact the strength of GBP, but it is rather low to begin with. Could BOE lower it further? Perhaps to negative rates even? Maybe. Nobody really knows at this juncture.

But with the already weakened pound, I’m betting that BOE will be mindful not to lower it any further, otherwise that will feed inflationary pressures.

110) Don't panic!.jpg

Panic. There was certainly panic. Fortunately, due to geographic location, I naturally do not have much exposure to GBP or British equities to begin with. (some limited exposure via the companies I own). Nothing to panic over.

Foreign capital inflows. My personal view is that this is overhyped. Foreign investment is not going to dry up overnight. It may get reduced upon leaving the EU, but it’d be gradual and I suspect, minimal.

EU barriers. Now this is certainly going to happen. But over what time frame? The UK has not even triggered article 50, hell, they havent even gotten the new government in and that’s due in September.

It is actually in UK’s interest to delay. And they sure are delaying. Only after sept, when a new government is installed, then they’d come up with a committee and this committee will take it’s own sweet time before even triggering the Brexit process. Once triggered, the whole thing will take another 2 years before UK exits.

In the meantime, business goes on as usual. We are looking at a long time frame. I think just 6 months from now, the markets will get used to this. Panic will subside, only the British will feel the heat in their everyday lives from reduced demand, a less vibrant economy, loss of jobs and tons of uncertainty.

In short, I’m betting on the pound right now. I’ve moved $80k into the GBP-USD at 1.33. (No GBP-SGD pairing is available). This is unlikely to be a long term holding though, I’ll be happy to take profits when it corrects till it’s closer to 1.4+. That’d be a healthy 6%+ ROI.

Now, there’s no doubt though, that this is currently a contrarian view. There are no analysts or banks recommending a long position on the pound right now.

Citigroup (and in fact most other banks), have a bearish stance on the pound. The recommendation is “to sell on rallies”. I’d admit that this is not something I’m overly confident about, which is why I’m allocating only $80k.

Aside from this, I’ve also picked up more shares in Valeant at $18.9 and Chesapeake energy at $4.1 over the rout last week. Within my portfolio, Valeant continues to be a major drag, but it is the one investment that I’m most excited about. I think there’d be more clarity once the coming 2Q results are released in end July/early Aug.



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