OpinionAug 1 2016

UK market is imitating Japan

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The idea of ‘Japanification’ has gained currency since the financial crisis. Over the past eight years, European markets in particular have become accustomed to ultra-low interest rates and bond yields, economic growth that bumbles along at best, and deflationary pressures.

The same trends also apply to the UK. But even those who believe we’re turning Japanese may not have foreseen one way in which London markets are now parallelling those in Tokyo.

By this I mean the way the pound is driving large-cap equities at the moment. As M&G has pointed out, the correlation between weaker sterling (relative to the US dollar) and a stronger FTSE is near a five-year high. The UK’s mega-cap overseas earners have flourished since the referendum in the expectation their revenues will be boosted by a falling currency.

There are clear similarities with Japan. The Nikkei has long had an inverse relationship to the strength of the yen. When the currency falls against the dollar, investors bank on exporters having an easier time of it, so up goes the index.

The correlation between weaker sterling (relative to the US dollar) and a stronger FTSE is near a five-year high

 

If this trend holds, what does this mean for UK intermediaries and their investments? Stocks have always responded well to easier monetary policy, of course.

But the stronger relationship with sterling means there’s yet another reason to pay close attention to the Bank of England’s plans.

This week, at the 88th time of asking, the central bank’s Monetary Policy Committee looks set to move interest rates from their record low of 0.5 per cent. Years of rate hike speculation have quickly been replaced by expectations of a cut.

Even if this doesn’t materialise, some form of additional easing – whether it be buying government bonds, incentivising banks to lend more to businesses, or even entering the corporate bond market – looks inevitable come Thursday. At the margin, it would suggest a weaker pound and therefore a stronger FTSE.

It’s worth pondering what happens next, however. You may think the downsides of Brexit are being overhyped, and the economy will turn out all right, in which case there will prove little case for further stimulus after this week. But if the economy does become mired in uncertainty, more easing will be expected – and the FTSE could remain dependent on the direction of sterling. The same would be the case if political developments trigger further moves in the currency.

Another line of action may be to exploit the discrepancies in this trend. Analysts at Liberum note that the 45 dollar earners in the FTSE 100 have risen 9 per cent on average post-Brexit, inversely proportional to the pound’s fall.

By contrast, the 66 dollar earners in the FTSE 250 have risen by less than 1 per cent. Something is amiss here, whatever you think of recent currency movements, and canny investors may be able to take advantage.

Dan Jones is editor of Investment Adviser