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BLOG: Why investors win when sterling falls

Joanna Faith
Written By:
Joanna Faith

The FTSE 100 reached record highs this week, while the pound plummeted. Darius McDermott explains why the currency and stock market have acted in a see-saw motion.

A friend of mine travelled to Europe last week and returned aghast after her experience at a local cashpoint. It’s nearly 1 to 1, she exclaimed!

Anyone planning a ski trip this season be warned. But investors should remember there’s another side to the story when sterling takes a tumble.

If the pound’s shocking slide and 31-year low has dominated financial news this week, it has had to share the limelight, at least, with another record breaker – the FTSE 100 hit an all-time high on Tuesday (11 October), as the UK’s largest companies continue to inspire confidence among investors.

In fact, the currency and the stock market act in a kind of see-saw motion in the UK – and indeed in many developed economies. A lower pound makes our economy much more competitive. It means our products are cheaper for other countries to buy, which gives a boost to exporters, such as drinks company Diageo, whose shares are up 21% since the day of the Brexit vote. Diageo brands like Johnnie Walker are obviously tied to the UK when it comes to manufacturing, and who doesn’t want to pick up a bottle of good Scottish whisky on the cheap? Iconic British manufacturer, Rolls Royce, has also seen a 22% share price rise since June 232 – presumably on similar logic.

It also means big multinationals like Unilever, Shell and BP, who earn a significant part of their revenues in overseas markets, stand to gain, because their profits should convert to a lot more pounds when they bring them back home.

So in fact it is the sterling weakness that has helped UK large-cap stocks perform so strongly post-vote. Funds that are well positioned to benefit from this trend include the Elite Rated Evenlode Income and Liontrust Special Situations, both of whom hold Diageo and Unilever among their top 10 stocks. The Elite Rated Schroder Income, which likes the oil majors for their dividend payouts, holds both Shell and BP.

In many ways, the currency has been a very useful ‘escape valve’ for the UK economy as the world adjusts to the idea of a non-EU Britain. By this I mean that the lower pound is essentially international investors’ way of ‘pricing in’ the impact of uncertainty. Without this, it would cost as much as it ever did to do business here, despite the fact that the outlook for trade and regulations is considerably less certain than it was. The sterling fall provides some compensation for this risk.

Inflation danger

One note of caution on the currency, however, is its potential impact on inflation. Warnings have piled up since the ‘flash crash’ last week, as while exporters benefit from a lower pound, costs only get higher for importers. And we do have quite a lot of crucial imports in the UK including the majority of our fresh fruit and vegetables and retail items like clothing, shoes and electronics.

Inflation measures the cost of living, so essentially if it is rising, it means our lives are getting more expensive. The Bank of England (BoE) has a mandate to keep inflation under control, which is usually achieved by raising interest rates. This puts the BoE in a bit of a conundrum, as it only just cut rates for the first time in seven years in August. It will now need to balance the competing needs of boosting economic growth and tempering inflation, which is a tricky tightrope to walk.

A bit of inflation protection would probably not go astray. Gold exposure can come in handy in this environment and I like the Elite Rated BlackRock Gold and General fund, which invests in the shares gold mining companies around the world – meaning it also provides some nice currency diversification. With a bit of luck, Britain’s farewell to the EU hopefully doesn’t have to mean farewell to holidays on the continent.

Darius McDermott is managing director of Chelsea Financial Services