The View

Sterling’s big blip provides a good illustration of the nonsense that can go on in markets

Instead of providing clarity, they are now complicating and exacerbating matters

PUBLISHED : Wednesday, 12 October, 2016, 8:39am
UPDATED : Wednesday, 12 October, 2016, 10:53pm

Last week there was a lot of chatter about a possible fat finger incident that may or may not have triggered a staggering 6 per cent plunge in the value of sterling.

Maybe it was not that at all but an opportunist play by currency traders trying to make a killing during a low volume moment in the market.

We may never know exactly what happened but we do know how currency and other markets have experienced extraordinary movements, sometimes by mistake and sometimes by design. We also know that, despite short-term excitement, markets have a habit of regaining their sanity over time but as they gyrate real pain can be inflicted.

Having written about markets over many years and been a minor league player I have to admit to more than a twinge of guilt over adding to the hype that surrounds markets which can overwhelm the reality of what actually happens in economies and business.

Perfect market theory, or the efficient market hypothesis, whatever you want to call it, maintains that asset prices fully reflect all available information thus markets are viewed as rational places providing a means of determining true value.

Like all absolutist theories this one is weak and has to be propped up by use of weasel words that kind of admit that markets might not be right all the time but suggest that in the long run they establish their supremacy as arbiters of value. However as the great John Maynard Keynes famously pointed out, “in the long run we are all dead”.

The final verdict on the fate of sterling has yet to be given but last week’s big sterling blip provides quite a good illustration of much of the nonsense we hear about markets.

The blip occurred in the wake of the British referendum vote to leave the European Union. Both sides of that debate use the markets to prove their point. Those who favoured remaining in the EU are leaping about saying, look what’s happened to sterling, we told you that Brexit would cause economic turmoil. They ignore the widely held view that sterling was overvalued prior to the vote.

Those who wanted Britain to exit the EU gleefully point out that while the pound fell the London stock market has been hitting new highs, indicating confidence in the result of the referendum.

They make this argument by selectively looking at the FTSE 100, dominated by overseas companies, while the wider based and more locally orientated FTSE 250 is not looking half as good.

Real businesses are largely unaffected by the roller coaster of investment markets. People running companies should have better things to do than glance anxiously over their shoulders at share prices

As ever, facts should not be allowed to get in the way of a good story and at this time of uncertainty over what will happen in the wake of the Brexit vote, the only sure fact is that the markets are complicating and exacerbating matters rather than providing clarity.

Real businesses are largely unaffected by the roller coaster of investment markets. People running companies should have better things to do than glance anxiously over their shoulders at share prices. The bottom line is that share capital is money already raised; changes to share prices won’t alter that fact.

It’s true however that currency fluctuation can impact the costs and profitability of doing business. However, as we have seen, currency values are not necessarily correlated with the state of the underlying economies they represent, were it otherwise the lacklustre growth of the US economy would have led to a far weaker US dollar.

It is therefore wise to be far more circumspect about market movements. However there is one area where market gyrations are rather more serious. This is in commodity markets that, on one hand, reflect the state of supply and demand but on the other can greatly distort businesses dealing in commodities.

Long gone are the days when people who needed, say wheat, for their business simply went out and bought it, big players will hedge their purchases and trade in these commodities, regardless of actual need. The situation is vastly complicated by the fact that among those trading are commodity producers who have insider information and can use it to their advantage in the markets. Meanwhile there is a cacophony of other players who trade commodities purely as a speculative vehicle.

The net result is that those at the sharpest ends of the commodity world – the primary producers and the ultimate consumers – often find themselves paying the price of speculation for their products.

This often leads to the creation of commodity bubbles, fueled by hyperactive futures traders making matters worse.

We are too far down the road of this nonsense and there is no realistic way of banning reckless commodity trading but maybe we can hope for greater market clarity and a bit of commonsense, or maybe not.

Stephen Vines runs companies in the food sector and moonlights as a journalist and a broadcaster