Personal Investing
Graham Smith, Market Commentator 7 Jun 2017 12:17pm

Do sterling's fortunes rest on this election?

SPONSORED FEATURE: As election campaigns go, this one has been full of surprising twists and turns

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Caption: The pound appears to be preparing for a rough ride.

Over the past five weeks, a more than comfortable lead in the opinion polls for Theresa May’s government has been whittled away to just a few percentage points. With just one week to go to the one poll that really counts, the pound appears to be preparing for a rough ride.

Ghosts of 1974 may have been troubling sterling. In that year, there were two general elections, both designed to land the government of the day a decent working majority. Both elections failed to deliver one.

The first, called in February by Conservative prime minister Heath following an extended period of industrial unrest, was supposed to settle the question of “who governs Britain?” The electorate spoke and it was Labour, which went on to form a minority government.

The second election that year was in October and it too was supposed to deliver a stronger mandate for the government of the day. That failed as well, in that Labour ended up with a majority of just three seats. The Labour government that was to follow was eventually forced to enter into a pact with the Liberal Party in order to continue passing legislation¹.

In politics as in life generally, overconfidence can be a dangerous thing. Markets tend to be good arbiters of mismatches between expectations and reality, which is probably why the pound has weakened again recently.

However, any lasting effects from political considerations might well require a hung parliament. A majority government with just a few seats to spare would provide some certainty about the future; an increased majority something better.

Either of these scenarios wouldn’t be the end of downward pressures on the pound though, since election uncertainty will soon give way to the start of Brexit negotiations on 19 June. A win for the Conservatives would likely be interpreted as a mandate for a hard Brexit and further threat to the pound.

Moreover, once the election is over, the economy is likely to retake its place centre-stage. Growth disappointed in the first quarter of this year (+0.2%) having proven remarkably resilient over the prior two quarters². We shall find out whether this new weakness is the start of a trend when the next quarterly growth data is published in July.

Although unemployment is at a 10-year low, the UK’s consumer-driven economy is susceptible to adverse changes in disposable incomes, and these are under pressure now that inflation (2.6%) is rising faster than average earnings (2.4%)³.

We often talk about the benefits of diversifying a portfolio of investments into other countries, and that remains as true today as ever. However, whatever the outcome of the election, there is a case for having a diversified exposure within the UK too.

Larger companies tend to have a larger exposure to foreign markets and so benefit from a weaker pound. Conversely, second-tier and smaller companies are more likely to want to see a stronger pound, because it reduces their input costs in relation to the sales they make in Britain and increases the buying power of their UK customers.

However, after a year of strong returns from the foreign earners that dominate the FTSE 100 Index, there is a risk that investing in large companies has become something akin to a “crowded trade”. By that we mean large numbers of investors may have substantially discounted the positive effects of a weak pound in their purchases to date.

Equally, with wages now growing more slowly than inflation and some believing that Brexit will result in significantly slower growth or even a recession for the UK economy, domestic earners may well have become overly depressed.

Fidelity’s Select 50 list contains several UK equity funds that go well beyond the reaches of the FTSE 100 in their search for successful, growing companies. Between them, the Threadneedle UK Mid 250 Fund and the Old Mutual Smaller Companies Fund encompass a broad range of businesses, from medium-sized down through small, and many of these are exposed primarily to developing trends in Britain’s domestic economy.

Select 50 funds with prominent positions in large overseas earners and more likely to benefit from further sterling weakness include the Fidelity Enhanced Income Fund and the Majedie UK Equity Fund.

Source:

¹ GOV.UK, 28.02.14 and BBC News, 05.04.05

² ONS, 25.05.17

³ ONS, 16.05.17 and 17.05.17

Graham Smith, Market Commentator

Graham Smith

Graham has worked for some of the biggest names in the City, including Schroders, Invesco Perpetual and Gartmore, as well as the World Economic Forum in Davos. Today he writes independently on a range of market and investment issues.

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