Time to think about currency risk in the UK?
It’s when you go on holiday that you’re hit with the low cost of sterling. I’m old enough to remember when my father came home with Deutschmarks for a family trip to the Continent – and got 11 to the pound.
In euros, it would be 5.5. The real rate for this week is around 1.18. This is not just a story of the UK’s relative economic decline, as many factors affect exchange rates, including the fact that the pound was overvalued in the mid-1960s when it began to fall. .
But Britain’s persistent failure to manage inflation well into the 1990s did much to undermine the pound. So does weak productivity growth. Fortunately, the UK’s economic performance then improved for quite a while and the pound has been rather more stable against the euro for three decades, even taking into account the success of the Brexit referendum.
The fact that I’m going to Germany soon – and through this year’s bout of weakness reminded me of my childhood memory DM. Since Russia invaded Ukraine, the pound has fallen 12% against the US dollar and shows little sign of recovery in the near future.
With many analysts forecasting the pound to fall further in the second half of 2022, there is little respite on the horizon for holidaymakers or – much more seriously – anyone buying anything at world dollar prices, such as the fuel and much of our food. . And that’s all of us.
What does all this mean for retail investors? This is certainly no reason to panic. As savers, we have been through episodes of sterling weakness before and will no doubt see more in the future. But this is a chance to examine the shape of your portfolio and rethink a key issue for many savers – a deep-rooted investment bias in favor of UK equities, at the expense of the rest of the world.
It’s true that the pound’s weakness this year is largely a reflection of the strength of the US dollar, which is near 20-year highs against a trade-weighted basket of currencies. Other major currencies have also weakened against the strong greenback, including the euro, down around 10% since the start of 2022.
Rising interest rates in the United States attract savings from around the world: the Federal Reserve is acting more aggressively in raising rates than other central banks, relying on the inherent dynamism of the American economy to quickly adjust and get by.
However, deeper concerns about the UK economy are also worrying investors. The Bank of England, to its credit, was the first major central bank to raise rates last year in the fight against inflation. But the pound’s recent slippage reflects traders’ concerns that the Old Lady may struggle to keep up.
Not only is UK inflation high by global standards – 9.4% in June, compared to 8.6% in the eurozone and 9.1% in the US – but its prospects for economic growth are weakening further. quickly than elsewhere as the post-Covid recovery slows. Next year’s output growth is forecast at zero by the OECD, the worst of any G20 economy except Russia.
Thus, BoE Governor Andrew Bailey may be forced by recession fears to delay rate hikes. And that drives the pound down. Or, as Barclays analysts put it: “We see near-term downside risks for the GBP primarily due to potential monetary policy divergence.”
Trying to guess short-term currency movements is widely considered a speculative game, which is not suitable for most retail investors.
But the market turmoil this year gives UK investors an opportunity to examine the balance between their holdings in the UK and overseas. The sell-off in global equities has hit the UK far less hard than its rivals. Since the start of 2022, the US S&P index is down 18% and the MSCI World Index is down 25%. UK stocks fared much better, with the energy-intensive FTSE 100 slipping just 3%. So now could be the time to take profits at home and invest abroad.
When we look long term, we can see that Britain – after recovering in the 1990s and 2000s – has fallen behind other developed countries over the past decade in terms of productivity growth, investment, research and development expenditure and real wages. Looking ahead, there may not be much change: the Office for Budget Responsibility says Brexit will be a lingering economic drag.
UK investors have responded in recent years by shifting money from UK-oriented funds to funds aimed at other markets, notably the US.
But overall, retail portfolios remain heavily weighted to the UK market. A Quilter poll last year of 1,041 people with at least £60,000 of investable assets found that 64 per cent had more than 25 per cent of their portfolio invested in the UK while UK equities only accounted for than 4% of the MSCI World Index. Almost half – 46% – had more than 50% in the UK.
It’s not as parochial as it seems. The UK economy is open and its stock market is dominated by global companies – with the FTSE 100 groups generating around 80% of overseas profits.
Strong companies can overcome local difficulties: great companies have been created in the UK over the last 50 years – chip technology group Arm, Vodafone and Ocado, for example. Others have seen strong growth, including AstraZeneca, Unilever and Diageo.
Still, just trying to pick global winners in London isn’t enough. The swimming pool is limited. And, above all, the market is oriented towards energy and mining groups. They happen to be doing well now – with high oil prices – but they barely represent the economic future. Tech companies, which surely do, are underrepresented.
David Henry, investment manager at Quilter Cheviot, says the time seems right to leave the UK. “The current point is an opportunity due to the global sell-off and the current outperformance of the UK market.”
He recommends reducing the national share of the equity portfolio to around 20-35% because “it is better to have global diversification by investing in the best companies in the world”.
There is certainly more value than a few months ago. The price-to-earnings ratio on the S&P 500 is around 20, down from a peak of 40 in December 2020.
But wealth managers warn against rushing out of one market and into others. Those valuations could look dangerously outdated if the expected slowdown turns into a recession and corporate earnings plummet.
So take your time, have a plan, and don’t act on impulse. The old advice to switch strategies in monthly steps is especially relevant in today’s volatile markets.
As for specific investment goals, Henry likes US tech, especially mature, profit-generating companies like Microsoft and Amazon, which are well-positioned to weather a downturn. Less Apple, as recession-hit consumers may balk at the high prices.
At Brewin Dolphin, Janet Mui, head of market analysis, has a keen interest in Asia and, in particular, China where she sees economic growth picking up again. “There’s a lot of peak pessimism about China, with the lockdown and so on,” she says. “But we upgraded in the last 6-12 months.”
Other wealth managers see potential in continental Europe, despite the Russian threat to stability and energy supplies. They like solid players such as Beiersdorf, the German consumer products group that owns Nivea, and Danone, the French food producer, as well as luxury brands, including Italy’s Moncler.
All good ideas: I plan to take a closer look at the European names as I ride France and Germany – and try not to think too much about DM11 per pound.