Shake It Off

Happy Sunday everyone. The last week and the coming week have been seismic in terms of political events but also in the world of Toronto sports and entertainment. This piece isn’t about the U.S. Presidential election, mainly because I wrote this piece a few days before the event. I hope by the time everyone is reading this we have a clear winner and our friends to the south can move forward and Shake It Off.

The two major events in Toronto have been the retiring of Vince Carter’s jersey by the Toronto Raptors and of course the upcoming series of concerts by Taylor Swift (who released the global hit, Shake It Off in 2014). I have been a Raptors fan since I moved to Canada in 1996, watched and cheered as Vin-Sanity took flight, but much like all Raptor fans, I had to Shake It Off when Vince demanded a trade in 2004. However, this past weekend I watched every minute of his tribute and the retiring of his jersey. Thank you, Vince!

Great Trades

Everyone remembers their greatest trades. On the night of June 24th, 1998, at General Motors Place in Vancouver, the Toronto Raptors entered the NBA Draft with the number 5 pick. They selected Antawn Jamison but immediately traded him to the Golden State Warriors in exchange for his North Carolina teammate, Vince Carter. This may go down as the greatest trade the Toronto Raptors ever made (although I would argue trading for Kawhi Leonard had a larger, albeit short term impact).

Within investing, there have been many great trades and some of these trades turned the investors into household names. The two that spring to mind for me are the shorting of the Great British Pound by George Soros in 1992 and the shorting of the U.S. housing market by John Paulson (and others) in 2007-2008. For any that aren’t familiar with the bet against U.S. housing that many made in that period, Michael Lewis’ book “The Big Short” or the movie adaptation are excellent.

The commonality with both great trades, was that in both cases the traders were positioned against market flows and therefore set to generate asymmetric returns from any reversal in flows. Fortunes can be made from investing with the crowd, but the greatest trades likely come from betting against the momentum. In the case of the Pound, George Soros was betting against a government.

The European Exchange Rate Mechanism

The Exchange Rate Mechanism (“ERM”) was formed in 1979 as a way for European currencies to trade with relatively fixed bands versus each other. The idea was that as their largest trading partners, this would create relative stability amongst the members and therefore strong growth. It was the basis of what would become the Euro in 1999.

The United Kingdom entered the Exchange Rate Mechanism (“ERM”) in 1990 at a rate of 2.95 Deutschmarks to the Pound. Under the mechanism, the Bank of England would need to use monetary policy, through open market actions and policy rates, to keep the ratio within a relatively narrow band (6% either way of 2.95). One of the problems with this approach is that the bands were public information and therefore subject to market manipulation. The market knew that at certain exchange rates, the Bank of England would be forced into action. This is exactly what happened in September 1992.

The Man Who Broke the Bank of England

Through 1992 George Soros started accumulating large positions betting against the Pound. In effect he was betting that the Bank of England would not be able to keep the exchange rate between Deutschmarks and Pounds within the allowed range. The more Pounds he sold, the more the pressure on the Bank of England to prop up the value of the currency. It seems hard to fathom but during the morning of September 16th the Bank of England used aggressive interest rate swings. The Bank of England increased interest rates that morning from 10% to 12%. In the panic, on the same day, they hiked interest rates to 15%!

Higher interest rates tend to make currencies more attractive on a relative basis. However, that assumes that there is confidence from the market that there isn’t too much risk assigned to that currency. That day, now known as Black Wednesday, saw markets appear to lose confidence in the Bank of England, leading to a large drop in the value of the Pound.

Source: Bloomberg

George Soros found the point of maximum pain, saw that the trading band was close to being breached and he pushed the government into drastic action. He won and it is claimed he profited by over 1 billion Pounds on the trade. The British government couldn’t Shake It Off with the U.K. being removed from the ERM and ultimately the Euro. Several years later the incumbent Conservative Party lost the general election to Tony Blair’s Labour Party.

For those of you in Toronto over the coming two weeks, it’s going to be a busy time as Swifties invade from all over the world. I have three words for those of you who are going to complain about the congestion this will cause … Shake It Off!

About Grayhawk

As a Chief Investment Office, Grayhawk Investment Strategies Inc. (“Grayhawk Wealth”) (“Grayhawk”) works with successful Canadian families to provide personalized investment management services, curated to help position them to achieve their wealth goals and accelerate their impact.

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