The dominance of the FTSE 100 by companies which earn the bulk of their income in overseas currencies means the UK’s domestic stock market can perform relatively well even in the event of economic turmoil, according to Rupert Thompson, investment strategist at Kingswood.
The dollar has strengthened significantly relative to sterling this year to date. Companies listed on the UK stock market that pay their dividends in sterling benefit from this, because they get more sterling for the dollars earned overseas.
From a UK fund’s perspective therefore, even if the company in which it is invested does not increase sales, it can still pay out a higher sterling dividend.
This is known to market participants as the translation effect.
Around 80 per cent of the earnings of FTSE 100 companies comes firm overseas.
Thompson says: “UK gilt yields have risen sharply with the 10-year yield hitting a new high of 2.9 per cent.. Rising rates and inflation are boosting debt service costs significantly and raising concerns over the state of the public finances."
He expressed concerns about the costs of the government's energy and defence policies.
While the new prime minister professes confidence in her ‘bold plan to cut taxes and grow our economy’, the reality is that the UK faces a very tough outlook with no easy solutions. Certainly, global investors are showing little faith with sterling’s descent against the strong dollar continuing – it has fallen to $1.15 and is down 15 per cent since the start of the year.
"The UK equity market should continue to fare rather better.
"While small and mid-cap stocks may continue to struggle as a result of their reliance on the domestic economy, the FTSE 100 will be supported by its overseas orientation and its relatively high weighting in oil companies and miners.”
Thompson adds: “The summer bounce in markets had always looked on thin ice given the deteriorating economic outlook and we are not overly surprised by its rapid demise. We expect the heightened volatility seen so far this year to continue for some time yet. Only when we get considerably closer to the peak in interest rates, are equities likely to see a sustained recovery.”