InvestmentsDec 19 2019

Turbulent week for sterling

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Turbulent week for sterling

Without sounding like a party political broadcast, as an avid, interested, long-term capitalist investor, last week’s election result was good.

I think the UK is a fundamentally entrepreneurial and aspirational country. However, what is the impact of the election result for investors?

I will deal with policy first. There were no policies from the Tories; nothing really on tax, investment, pensions, rates or reliefs.

The national insurance threshold is due to rise at some point, taking more people out of tax altogether, but aside from that there was nothing.

One glaring long-term issue to sort out is the pensions mess that George Osborne has leftus with.

Reducing the cost of higher rate relief is fair in my view, but penalising risk-taking and returns is not.

However, and I am not a pensions expert, it is complicated, hence no policy, but it is high time it was sorted.

Another area is social care, but as Theresa May found out, it is a vote loser and therefore all parties keep brushing it under the carpet. Taxes of some sort will have to rise to pay for it.

So on the policy front, that is it.

On to more interesting matters about investing.

Sterling

As predicted, we have already seen a sharp rise in sterling since it was obvious the Tories had won a convincing majority, however it has since fallen back again as worries resurface about a no-deal Brexit in a year’s time.

But many think it is still undervalued and will gradually continue rising.

This is a double-edged sword though.

As we are a nation that imports lots of everyday goods, rises in sterling will help keep costs down.

The problem comes when you turn to the stock market and sterling’s effect on it.

More than 70 per cent of FTSE 100 earnings come from overseas, so a stronger pound makes those earnings, and subsequent dividends, less valuable. The EU referendum had the opposite effect, boosting dividends.

Inflation

As sterling rises, inflation will (all else being equal) fall as our pound goes further.

Oil, for example, is priced in dollars, so the overnight 2 per cent increase in sterling will help keep oil price rises in check as well as food prices.

The knock on impact of the pound going up is less need for interest rate increases to combat inflation.

Stock markets

As has been repeated many times, the UK is cheap and unloved. Brexit uncertainty and political chaos has meant no one wants to invest, even at massively depressed prices.

As an example of the cheapness, the gap between dividend yield and gilt yield is the widest since the 19th century.

Now that there is more certainty and a stable five-year government, I expect overseas investors to return and start looking at the fundamentals again.

Domestic stocks should see the strongest bounce as there has been a disconnect between perceived domestic stocks and overseas ones.

The FTSE should advance, but not in huge leaps and bounds. I am a buyer of UK equities today, as I have been for many years.

Bond markets

In my view, a Labour government would have led to sharply rising borrowing costs due to its huge spending and nationalisation plans.

But what of the new Tory government?

Its spending plans are also large and unfunded. In other words, spending plans will outstrip tax receipts.

Will there be enough demand for the expected supply of new gilts?

As a sovereign stable nation, yes, there should be enough willing buyers.

However, with rising deficits and as a country importing more than we export, I can see borrowing costs going up – not back to the levels of yesteryear, but a 10-year yield of 0.82 per cent does not seem right when the Bank of England is not buying.

Brexit

Stage one of Brexit will be done by the end of January. Stage two will be as tortuous.

Negotiating a trade deal with the EU will not be straightforward and we could well face another cliff edge no-deal Brexit in 12 months time.

However, my gut instinct is that Boris Johnson will not have to kowtow to the hardline Eurosceptic faction and if a trade deal is not completed in time a fudge will be the order of the day.

Ben Yearsley is co-founder and a director of Fairview Investing