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A sentimental view of Brexit

Crowd-sourced sentiment indicators could have made the Brexit ride somewhat less nerve-wracking, certainly more profitable.

Article by Ryan Shea, head of Research, Amareos

The UK referendum on EU membership held on June 23 was one of two key political risk events investors were firmly focused on going into 2016; the other being November’s U.S. Presidential election. Opinion polls suggested that the vote would be close. Given the near-unanimous consensus among policymakers and economists as to what the dire economic consequences of leaving the EU would be, many investors had a sneaky feeling that, in the end, the result would go the way of the 2014 Scottish referendum, meaning the status quo (a Remain victory) would prevail.

In this instance, however, history did not repeat and the UK electorate voted to rescind its membership of the EU; a decision that sent shockwaves around the global and put UK financial assets and sterling into a tailspin.

Fast forward to today, just over two months after the vote, and the environment is rather different from that envisaged by the doomsayers. Tumbleweed is not blowing across deserted high streets up and down the land.  Moreover, and less anecdotally, macro data shows economic activity has bounced back; UK stocks at one point were up 10% from the post-Brexit low and even sterling has witnessed a broad-based bounce over the past few weeks.

Brexit pessimists argue that it is much too early to conclude that the impact of the referendum result on the UK economy is more benign than feared. This is an argument with some legitimacy given Prime Minister May has still to trigger Article 50, required before formal withdrawal negotiations can begin.

They also argue that the economic rebound apparent in the macro data occurred because of the swift and aggressive policy response from the Bank of England in response to the crystallization of downside risks; an argument with much less legitimacy given that a monetary policy response should have been factored into earlier bearish projections.

However, all of this is of little comfort to investors who have had to endure the financial market equivalent of a rollercoaster ride.

Tapping into Brexit market sentiment

One information source, newly available to financial market participants, that could have made this ride somewhat less nerve-wracking – certainly more profitable – comes from crowd-sourced sentiment indicators.

Available in near-real time these indicators, which are included in the Amareos app recently launched on the Thomson Reuters Eikon App Studio (see screenshots below), use automated processes to extract crowd sentiments from over one million articles published daily from up to 50,000 sources including mainstream press, blogs and social media.

Amareos Eikon App screenshots

Exhibit 1: Amareos Eikon App Screenshots



By analyzing UK sentiment trends both in the run-up and subsequent to the referendum, it was possible not only to get a very effective lead steer on the “surprise” result, but also on the subsequent economic and financial impact.

Project fear fail

The first sign that things were not going well for Remain, even though they were generally ahead in the opinion polls, came in late April.

Right from the very start of campaigning, Remain focused on the negative economic consequences of leaving the EU; indeed, it was such a central part of their message that the campaign was soon nicknamed Projection Fear (or Operation Fear).

Early on this tactic worked. The ‘Sterling Fear’ index, one of eight primary emotions that can be identified using the aforementioned process, soared to its highest possible level (the individual emotion indices are calibrated to range from 0 the 100). However, from mid-April onwards the Sterling Fear index started to decline. This was, clear, quantifiably verifiable, proof that the campaigning strategy adopted by Remain had become much less effective. Indeed, on June 1 we tweeted on this significant shift in public perceptions.

Shift in public perception 


The second signal from crowd-sourced sentiment indicators that the vote would not go Remain’s way came in the very last few days of the campaign.

While UK financial assets (proxied in the lower exhibit by the FTSE100 price index) enjoyed a last minute rally on anticipation that the status quo would be maintained (that sneaky feeling we referred to at the outset proved persistent), UK country sentiment (and economic growth sentiment) continued its inexorable slide. The message was clear – the crowd view was that Brexit would occur; even if the crowd itself didn’t realize it or financial markets for that matter.

UK financial assets proxied by FTSE 100 price index


Rather obviously the downtrend in public perceptions of UK economic growth accelerated in the days following June 23 as everyone faced the reality of the first ever exit from the EU club (Greenland’s vote to exit in 1985 doesn’t really compare). Given the scarcity of “hard” macro data by which investors could assess the negative impact of the Brexit vote these sentiment indicators provided a useful “first gauge” by which to quantify the likely extent of the damage (see exhibit below).

Sentiment toward UK real estate


As many readers will appreciate, amongst the most-timely data on economic activity in the UK – and for most major economies – is the monthly purchasing managers index (PMI) business surveys.

According to the flash manufacturing and services PMIs, published on July 22, in the month immediately following Brexit economic activity strongly decelerated. Indeed, the final readings, released in early August, were confirmed as being at levels consistent with imminent recession. Specifically, the final July manufacturing PMI survey, published on August 1, fell to 48.2, some 3.9 points lower than the June readings – a big m/m drop). Meanwhile, the final services PMI, published two days later, fell an even larger 4.9 points relative to the June reading, to 47.4. In short, the first “hard” data pertaining to the post-Brexit period was consistent with pre-vote fears.

It was not until the release of much better-than-expected July UK retail sales data on August 18 that investors began to seriously question whether the British economy had been so badly affected by Brexit.

Compare this timeline with the behavior of crowd-sourced UK economic growth sentiment shown in the exhibit below. The sharp downtrend that had begun even prior to the June 23 vote continued until August 8, whereupon it began to reverse – just days after the final July PMIs were published and well before the release of the strong July retail sales report (see exhibit below).

Crowd-sourced UK economic growth sentiment

The UK sentiment data we track at Amareos not only provided investors with an early (hence valuable) warning signal that Brexit was likely, but it provided a very effective way to monitor the knee-jerk drop and subsequent rebound while waiting for the “hard” macro data to catch-up.

What the chart also illustrates is that when the better “hard” economic data were subsequently released, because sentiment was still weak (albeit improving) market conditions were ripe for a solid rebound in UK assets, including the beleaguered currency.

Concomitant with rising public negativity towards UK economic growth prospects, sentiment towards the UK currency also fell sharply. Such extreme sentiment – in this case pessimism – is an important consideration for investors.

Smarter crowds

One longstanding school of thought is that crowds are, in some sense, “smarter” than the individuals that comprise it. The basic premise being that each individual has some knowledge but it is imperfect or incomplete. What this means is that in, say, a forecasting exercise, each individual will make a prediction error. But, when individual forecasts are averaged over a large enough sample, these prediction errors cancel out, such that the crowd estimate is the most accurate. In many spheres this result has been validated. However, for this predictive outperformance – the ability to tap the collective wisdom if you like – to be valid depends upon four criteria being met. These are:

  • Decentralization
  • Aggregation
  • Independence
  • Cognitive diversity

Failure to satisfy these four criteria jeopardizes the crowd’s ability to generate the best estimate or devise the best solution to a problem; often resulting in spectacular fails. As evidenced by numerous asset price bubbles observed over the centuries, a great deal of these fails have occurred in finance, so it is hard not to conclude that financial markets are poorly suited to exploiting the wisdom of crowds.

Of the four criteria, the most problematic for finance is independence. It is simply impossible for investors to be fully independent of each other because investment success depends not only upon the outcome, but on how much it differs from what was originally expected or anticipated. That is to say, investors must necessarily take on board the opinions of other investors in order to be successful.

This is good news for investors, however, because if it were the case that the crowd was always smarter then the individual we would be inhabiting the perfect world of the “efficient market” where alpha-generated did not, indeed, could not exist.

Moreover, by monitoring crowd-sourced sentiment indicators it is possible to identify situations when the probability of crowd fail is high, namely when the heterogeneity of investor views is low, which is another way of saying that the correlation of views is high. Such occasions are defined by sentiment being either extremely high or extremely low.

Sterling over the past month has been a clear example of this. In late July we noted that:

In our experience the most profitable trades turned out to be the ones with the least initial buy-in (low popularity). Right now, GBP longs fit right in that camp.

When the better “hard” economic data were subsequently released, because sentiment was weak, market conditions were ripe for a solid rebound in GBP as this negativity was reduced. In fact, over the next few weeks the UK currency rallied more than 5% versus the USD and 3% in tradeweighted terms.

In fact, as can be seen in the exhibit below, over the past few weeks the UK currency has rallied more than 5% versus the USD and 3% in tradeweighted terms as crowd sentiment towards Sterling has sharply rebounded.

Crowd-sourced Sentiment versus Trade-weighted GBP


In summary, Brexit has been an important use-case for the real-time crowd-sourced sentiment indicators included in the Amareos App on Thomson Reuters Eikon Studio. Understanding how the rest of the world thinks about a potential investment or macro theme is a key element of any robust investment process. After all, how can one hope to beat the crowd – the goal of alpha-generation – if one has no idea what the crowd view is?

All views are those of Amareos, not Thomson Reuters

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