The FTSE 100 hit a one-year high yesterday. Stocks are merrily marching higher as though they hadn’t a care in the world.
The pound isn’t quite so lucky. Sterling hit a six-month low against the euro, and it’s even been falling against the dollar, which is currently one of the world’s most despised currencies.
That’s what happens when your country’s leaders go scrabbling in the grab-bag for assets to sell off in a desperate attempt to fix the nation’s finances. But that’s not the only reason for the pound’s pain…
Life’s tough for the pound right now
A number of factors have made life even tougher for the pound so far this week. For one thing, there’s the unedifying sight of our politicians’ undignified reaction to the expenses scandal flaring up all over again. As Allister Heath put it in City AM this morning, “Britain’s political establishment is indeed its weakest link, with insufficient collective self-control to take decisions that are truly in the public interest. No wonder we are in such a mess.”
Nicely put. Perhaps more important to the currency markets is the very obvious fact that no one is really proposing any concrete ways of dealing with Britain’s dodgy public finances. On the one hand, neither the LibDems nor – in particular – the Tories want to reveal any fully-fledged ideas for fear that Labour will pinch them.
And in the absence of any policies to pinch, Labour seems to be scrabbling around somewhat desperately for solutions that will enable it to spend even more money yet somehow make a claim for fiscal responsibility. Hence we have the notion that everything from the Dartford Tunnel to the Royal Mint will be up for grabs in a mass sale of the family silver. You get the idea that if there was a sort of global pawnbroker for nation states, we’d have headed off down there by now.
As if that wasn’t bad enough, we had plenty of other reminders about the state of the UK economy. The Centre for Economics and Business Research (CEBR) said that it reckons UK interest rates could stay at 0.5% until 2011, and below 2% until 2014, during which time the pound could fall below €1 (although, says the CEBR, that depends on how worried markets get about the “long-term sustainability of the euro”).
Meanwhile, accountancy group PricewaterhouseCoopers says that Britain is going to have to raise taxes by £26bn a year, or cut public spending by 17% a year in the three years to 2013-14, over and above measures proposed in this year’s Budget.
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Why the surge in the FTSE?
All told, the pound doesn’t have much going for it right now. So why the surge in the FTSE 100? Well, truth be told, the weak pound might actually be good for the FTSE – or at least, for a significant proportion of the stocks in it.
Graham Secker at Morgan Stanley points out that “significant” falls in the pound tend “to be bullish for UK stocks relative to their global peers.” For example, during previous sterling slumps, the UK market has risen by an average of 16% compared to 11% for the rest of the world, or 8% for continental Europe.
Secker points out that there’s a good reason for this – almost half of UK earnings, and about the same proportion of dividends, come from companies that report in US dollars. So a sliding pound effectively means more profits and dividends – at least in sterling terms.
Another good point that Secker makes is that when the pound is cheap, overseas companies might be encouraged to buy firms in the UK. “External-facing sectors where UK valuations are cheaper than their international peers are: Materials; Capital Goods; Pharmaceuticals and Telecoms.” Secker adds: “UK valuations are also cheaper for Consumer Services and Retailing, but these sectors’ domestic focus arguably makes them less attractive.”
Where to invest at the moment
So what does this mean for investors? Well, the pound is likely to remain pretty fragile. Another slump in global markets would probably be good for the dollar, but not for sterling.
But we wouldn’t pile into markets wholesale. After all, as Secker says, there’s a pretty specific subset of stocks that do well from sterling weakness. And many of them are the more defensive stocks that we’ve been tipping for a while. As my colleague David Stevenson pointed out yesterday (Snap up drug stocks while they’re still cheap), the pharmaceutical sector is looking good and will certainly benefit in sterling terms from a weak pound.
Meanwhile, although there have been some concerns raised over the ability of the oil majors to maintain their dividends next year (How to protect your wealth from the dividend crunch), as we pointed out last week, if there are any cuts, these may well be offset by sterling weakness.
And of course, as we’ve mentioned many times before, if you’re looking to defend yourself against currency weakness across the board, gold is a good asset to have in your portfolio. In dollar terms it’s well over $1,000 an ounce right now, but in sterling terms it’s yet to breach its record high. My colleague Dominic Frisby has more on how high gold could eventually go in tomorrow’s Money Morning.
Our recommended article for today
A better way to play the US dollar
It’s too soon to write off the US dollar, says Merryn Somerset Webb. When stockmarkets fall, the dollar will bounce back. But if you want to bet on that, there’s a better way to do it than buying greenbacks.