The weakness of the pound will have perplexed many holidaymakers this summer. Buying euros in the “wrong” place – at some international airports, for example – might have proven expensive. Reportedly, one pound was buying only 85 euro cents at Heathrow late last month¹.
Such has been the price of intensifying concerns about a no deal Brexit, a possibility Britain’s new prime minister seems to have successfully convinced markets of. Boris Johnson will be hoping the EU feels the same way, as he pursues a new withdrawal deal in the autumn. The signs so far are the Union will be harder to convince.
The vagaries of the foreign exchange markets have important consequences for investors too. What a company earns from its investments overseas can be critical when the foreign exchange in its tills is converted back into sterling.
Another important factor is competitiveness. A British company operating overseas at a time when the pound is weak can either choose to reduce or hold back its prices to help gain market share or keep its prices the same and take a bigger profit on each item it sells.
The construction equipment hire firm Ashtead is one company that has stood out recently for the positive tone of the statements attached to its results. Ashtead’s most important market by far is North America, a strategy that appears to be paying off with the company reporting strong end markets and a structural growth opportunity as it increases market share and diversifies².
These are not benefits open to UK companies that primarily serve customers in Britain. For them, sterling weakness simply means having to pay more for some of the raw materials they have to buy and probably less money in their customers’ pockets. Most of us, after all, are exposed to the fluctuating prices of foreign goods and services somewhere along the line.
This is where a significant caveat lies for foreign earners too. A finished goods manufacturer may also suffer higher costs for the raw materials it buys. However, assuming it’s selling its goods at a profit, the overall effect of a weak pound should be positive.
So where have these effects left the stock market? Usefully the Cboe Brexit High 50/Low 50 indices have answers. These indices track the performance of FTSE 100 shares ranked by the proportion each company earns in the UK. The Brexit High 50 is made up of the 50 companies earning the most domestically.
As expected, the effects have not been completely clear-cut for all businesses, but shares in UK companies that have previously spread their wings overseas have performed considerably better overall since the start of this year³.
Even taking account of the many stocks that have benefited from sterling weakness and performed well partly because of it, the UK stock market remains attractively valued. The MSCI United Kingdom Index traded on about 14 times the earnings of the companies it represents at the end of July, compared with around 18.5 times for world markets generally⁴.
Only about a quarter of the FTSE 100’s earnings are home grown, so this gives a clue as to just how inexpensive many domestically focused companies have become. The “once in a generation” uncertainty posed by Brexit arguably accounts for the missing part in valuations.
In the current environment, corporate UK may be quite a hard sell to foreign investors. Accounting for less than 6% of the world’s stock markets, it’s relatively easy for them to look elsewhere⁵.
If once they invested in the UK for a foothold in Europe or even an exposure to the rest of the world, they may now see other countries like Germany or the US as being better alternatives, far from the currency and Brexit risks of Britain.
However, the already long-drawn-out Brexit process has provided ample time for markets to account for risks like these and, it seems, not the possibility of any reasonably positive political or economic outcomes. In a world where economic growth is slowing down, the UK might turn out to have been a decent choice.
With tax receipts now rising at a respectable pace – up 4.8% in 2018-19 compared with the previous year – the government should be in a better position than three years ago to lift the economy if need be⁶.
Fidelity’s Select 50 list includes several highly respected UK equity funds with contrasting investment approaches. The LF Lindsell Train UK Equity Fund needs no introduction and is a good place to find UK multinationals. Its relatively concentrated portfolio features long-term investments in a number of global consumer groups, including Diageo, Unilever and Burberry.
The Franklin UK Equity Income Fund looks rather different, with its balance of stocks paying higher than average dividends and stocks growing their dividends at a faster than average rate. Again, multinationals are in firm evidence among the largest holdings, but you’ll find a good spread of domestic names here too, including Bellway, DFS Furniture and Tesco⁷.
¹ The Independent, 30.07.19
² Ashtead Group, 18.06.19
³ Cboe, 06.08.19
⁴ ⁵ MSCI, 31.07.19
⁶ HMRC, 21.06.19
⁷ Franklin Templeton, 30.06.19
Important information The value of investments and the income from them can go down as well as up, so you may get back less than you invest. Investors should note that the views expressed may no longer be current and may have already been acted upon. Overseas investments will be affected by movements in currency exchange rates. Reference to specific securities should not be construed as a recommendation to buy or sell these securities and is included for the purposes of illustration only. Select 50 is not a personal recommendation to buy or sell a fund. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to an authorised financial adviser.