How to play a sterling recovery: three sectors tipped to shine

The snap election announcement made earlier this week by prime minister Theresa May has been given the thumbs up by currency markets, sending the pound to its highest level in 2017. 

At the time of writing (10.20am) £1 buys $1.28, up from $1.24 three months ago, while against the euro £1 buys €1.19. On 20 January, £1 was worth just under €1.16.

In stark contrast the FTSE 100 index has taken the news of the snap election less positively, declining 3 per cent since the announcement. In doing so, it continues an association that has been strongly in evidence since last June: when the pound rises the FTSE 100 falls, and vice versa. 

Over this 10-month period the UK’s stock market has been the big winner. 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. 

As Money Observer has previously noted, given the international make-up of the FTSE 100, various sectors benefit

But the question, although admittedly these are early days, is whether this trend will now reverse, which may strengthen the case for taking a closer look at domestic stocks. 

Colin Morton, manager of the Franklin Templeton UK Equity Income fund, thinks it is too early to call, but he expects further sterling upside from here.

‘A more significant impact on equity markets would be a reversal of the currency impact, which has been benefiting a number of overseas earners listed on UK indices that, since Brexit, have been enjoying the translation effect resulting from a weakening pound. 

‘There are already a few signs that the anticipation of a more stable Brexit negotiation could be a game-changer for currency, potentially rallying the pound from its low levels and thereby removing the benefits the consumer goods companies in particular have been relishing.’

However, Morton warns that we will have to wait and see how the currency movement pans out. Such a move, he adds, ‘could boost UK domestic stocks that would see production costs overseas go down’. 

 Three sectors to consider if sterling stays strong 

According Russ Mould, investment director at broker AJ Bell, ‘if sterling does continue to rally, investors may choose to focus on those sectors that have been neglected since the Brexit vote because of their reliance on the UK economy – namely general retailers, food retailers and the real estate plays.’ 

In the general retailers space Mould names Next, Dunelm and Mothercare as three firms that will benefit from cheaper raw material costs in the event of a stronger pound. He flags Tesco, Sainsbury and Morrisons as the main three food retailers that would welcome a sterling recovery. 

Turning his attention to real estate, Mould makes the point that real estate investment trusts (Reits), like housebuilders, took a drumming on the back of the referendum result last year. But whereas the housebuilders have recovered, Reits have yet to recapture the lost ground.

‘If the market decides to start looking for domestic value plays, both areas may therefore come onto traders’ radars, especially as they have already started to run,’ adds Mould.  

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