When the general election was called six weeks ago, Theresa May’s Conservative Party was expected to canter to an easy victory.
While it is expected that May will keep the keys to number 10 Downing Street, there is now much uncertainty over how a big a majority her Conservative Party will end up with.
As far as investors are concerned, sentiment surrounding the pound will dictate the fortunes of the stock market, as it has done repeatedly over the past year.
When the snap election was called on 20 April, for instance, the pound strengthened to reach its highest level in 2017, with £1 buying 1.28 US dollars, while against the euro £1 bought €1.19. In stark contrast, the FTSE 100 index took the news of the snap election less positively and declined, before quickly recovering its poise as the pound’s rally proved to be shortlived.
But in the event of a sustained sterling rally playing out, either following the general election outcome or in the months to come as the Brexit negotiations begin in earnest, it could be bad news as far as UK investors are concerned.
The reason is simple: around 40 per cent of UK companies pay dividends in either dollars or euros. A cheaper pound therefore makes their exports more competitive and boosts their earnings.
Just like a year ago, the key to understanding the impact of the election will be the pound. It is always the lightning rod for uncertainty,’ points out Tom Stevenson, investment director for personal investing at Fidelity International. ‘The pound will, therefore, be the first thing I look at in the early hours of Friday morning. And it will continue to be the main focus once the Brexit negotiations begin 10 days later.’
The reversal of the weak currency trend that has benefited various blue chip names in the FTSE 100 is expected to play out if the Conservative Party secures a big majority.
Paul Mumford, manager of the Cavendish UK Opportunities fund, expects the pound’s fortunes to be boosted in this scenario, but he sees market benefits nonetheless.
‘While the inevitable sterling fall post-referendum has been useful for exporters, the eurozone continues to look wobbly and there is every reason to expect sterling to regain ground thanks to its safe haven status over the mid-term. This would help domestic businesses, although of course it will hurt exporters on the flip-side.’
In contrast, under a shock Labour victory the pound is likely to fall and hand FTSE 100 companies a short-term boost. But over the coming months ‘a Labour win may not be any better [for the market] either’, points out Stevenson. He adds that when the dust settles the FTSE 100 could sell off heavily.
‘The implementation of the most radically socialist agenda since Michael Foot’s 1983 “suicide note” would explicitly target corporate earnings and is likely to lead to a severe market correction,’ says Stevenson.
On the other hand, the size of the Conservative Party’s majority could ‘disappoint what has been a consistently strong UK market’, according to Holly Cassell, deputy fund manager of the Neptune UK Mid Cap fund.
Regardless of the outcome, Cassell’s view is that the pound will not rebound strongly as she expects uncertainty to persist throughout the Brexit negotiation period.
The bottom line, of course, is that currency markets are not only notoriously hard to predict but also relatively short term, and that long-term investors should resist the temptation to make knee-jerk responses to currency-linked market movements.
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