‘If ignorant both of your enemy and yourself, you are certain to be in peril’– Sun Tzu
Hands up if you have started a diet this year? If only losing the pounds was as easy as how the British Pound has shed its value so far this year against most currencies apart from the heavily pressured Turkish lira and Mexican peso!
Every commentator has – of course – jumped on the U.K. Prime Minister’s interview on television last Sunday, when she hoped to gain concessions in all areas, and also appeared to hint that if this was not the case then, rather than keep ‘bits’ of the previous relationship, a harder Brexit would result. Perhaps we will find out more next Tuesday.
In the meantime the Pound’s weakness has helped the FTSE 100 index of leading London-listed shares to thirteen successive highs and – as I write – a fourteenth is a distinct probability. Of course there is some logic to this given over two-thirds of corporate earnings from FTSE 100 constituents come from overseas and a falling Pound boosts the value of such earnings.
Since starting to write these columns back last autumn, I have continually returned to exchange rates as the source of greatest insight for investors, most notably around the US dollar and global risk preferences.
They historically have also been a superb indicator of political angst, and the currently troubled Pound is no exception. Early this week I mused to someone that surely is was just a matter of days before somebody puts up a chart of various Pound cross rates showing that, at various levels, certain Brexit outcomes are the priced-in realities…and within a day someone did.
Apparently the Pound in your pocket down to 1.10 dollars equates to a ‘hard Brexit’ whilst a return to the 1.55 dollars level of a pre Brexit referendum world would equate to a ‘soft Brexit’. And where are we today as I write? A Pound gets you 1.22 dollars. So its level at this moment in time is suggesting a clear bias towards a ‘hard Brexit’ outcome.
As I said before we may find out more on Tuesday but everything I see at the moment suggests a delayed and pragmatic Brexit. Last Sunday’s interview was just an attempt to establish a bit of negotiating credibility. In reality the Prime Minister – a bit like all the European political leaders struggling with a very mixed backdrop – is (to twist a famous Teddy Roosevelt saying) talking tough and carrying a small stick. Which is why I believe a fairer value for the Pound against the US dollar today is somewhere between those two numbers. Let’s call it 1.35 dollars for the Pound in your pocket.
Few agree with this but I have some support from my old friend the Big Mac index. I know in the space of a few paragraphs I have shifted from talking about diets to getting excited about a fast food favourite but this attempt to use a standard, staple consumer product to identify where currencies are over and undervalued.
Having spent a couple of decades looking at various foreign exchange models I have to say its simplicity is attractive and – over time – pretty accurate. Anyhow this measure suggests the dollar ‘… is massively overvalued against its three biggest rivals: the euro (16.6%), the Japanese yen (31.2%) and the British pound (21.8%)’.
Crikey. Now given the U.K. economy has so far avoided Japan’s double whammy related to demographic and low inflationary expectations, my feeling is that gravity will be re-established over time, and starting this year probably from Tuesday onwards. And, of course, this changes the type of shares you should be buying…and the profile of FTSE 100 returns.
Here’s my prognosis for 2017. A higher Pound and a FTSE 100 that stops racking up the all-time highs and is driven not by miners, energy, industrial exporters and overseas earners but banks, UK consumer names and more domestic plays. And this is no disaster – did you pick up the reasonably solid statements from the likes of Tesco, Morrison and Sainsbury’s during the last week?
Stock markets always favour the brave and insightful and these remain the traits for investment success in 2017 rather than index gains as the Pound wilts. Something to ponder as you start to reconsider a foreign trip later on in the year when the currency in your pocket will have a bit more purchasing power.
Chris Bailey has 20 years of investment industry experience at long-only and long-short institutions as a global multi-asset fund manager, strategist/macro thinker and, in the earlier part of his career, as a securities and fund analyst.
In 2013 he founded Financial Orbit focusing on daily macroeconomic comment and securities analysis. In December 2016 his Twitter account (@financial_orbit) was named as one of the ’50 accounts investors should follow in 2017’.
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