The pound has rebounded significantly against the dollar since its plunge after the EU referendum, but mixed signals might leave investors with pause for thought.
Sterling has been on a tear against the US dollar in recent weeks, reaching a post-referendum high of £1 to $1.43. This could provide a significant signal to investors that it is time to invest in domestic UK equities (companies) as companies and consumers purchasing power improves.
AJ Bell’s investment director, Russ Mould, explains: “Since the UK’s vote to leave the EU in June 2016 one straightforward trade has been ‘pound down, FTSE 100 up’ as a result of the high proportion of stocks with a big percentage of their earnings overseas. But the pound’s sudden surge could force a rethink and lead investors to focus on neglected plays on the domestic economy.
“Such sectors include Travel & Leisure, Real Estate Investment Trusts (many of which look cheap relative to their asset base) and particularly General Retailers.
“A sustained gain in sterling would help to restrain cost pressure on restaurateurs’ and retailers’ imported goods or raw materials and also benefit consumers’ wallets and purses by keeping inflation in check and helping wage growth to catch up.
“While history is no guarantee for the future, the FTSE All Share General Retailers sector does look to do better when the pound is strong and less well when it is weak.”
However, there are some significant caveats in the surprise strength of the pound against the dollar.
Lee Wild, head of equity strategy at interactive investor (Moneywise’s parent company) explains: “Sterling is up as much as 6% against the greenback in the past fortnight to over $1.43, never good news for FTSE 100 multinationals whose foreign income is now worth less in pounds and pence.
“With Brexit trade talks not due until March, and in the absence of negative catalysts, there’s a five-week window for the pound to go higher still. For the FTSE 100, the magnetic attraction of 7,600 or lower could prove too difficult to avoid. A hoped-for bounce from there will potentially decide whether we see a high at or above 7,800.”
‘The pound’s current purple patch cannot be counted on to endure’
There is also an underlying confusion on the perceived cause of strength in sterling that comes as a reminder to investors to remain cautious when it comes to investing in UK equities.
David Lamb, head of dealing at FEXCO Corporate Payments, comments: “It’s tempting to see the pound’s mercurial rise this week as a sudden reversal of fortune. But its rapid appreciation against dollar – smashing through the psychologically important $1.40 barrier – is less a sterling success story than a lament of dollar weakness.
“The real credit for the spike past $1.41 lies not with Britain’s robust jobs market [referring to record-high employment levels], but rather with US Treasury secretary Steve Mnuchin’s efforts to talk down the dollar.”
Trevor Greetham, head of multi asset at Royal London Asset Management, agrees: “If the recent strength in sterling were linked to progress on Brexit, you’d envisage seeing UK interest rate expectations rising, relative to the US. In fact, the reverse has happened. The dollar has weakened despite a marked increase in US interest rate expectations relative to the UK and other countries.”
Mr Lamb adds: “Some sterling bulls have begun predicting that the Bank of England could raise interest rates as many as three times this year, but this seems premature. UK monetary policy is likely to remain more dovish than the Fed’s in 2018, meaning the pound’s current purple patch cannot be counted on to endure.”
Mr Greetham concurs: “This creates the risk of a snap back in the dollar and a sudden drop in the pound, regardless of the state of the negotiations in Brussels.”