Investment Outlook for UK-based Investors

by George Hatjoullis

On 26/12/2014 I posted a blog entitled UK Equity Market in 2015 In which I discussed the market in relation to the political environment and concluded it was no obstacle to the market moving higher. On 21/01/2015 I added an even more bullish postscript based on a benign interest outlook. So far so good but it seems worth updating periodically. The FTSE has made an all time high, retested support (the 200 day moving average) and made a new  closing high. This is precisely the pattern that one would expect if the trend is to be higher.

FTSE daily

This bullish price dynamic has been achieved despite the same political uncertainty discussed in December and much ambiguous commentary on the state of the economy. My words are deliberate. The state of the economy is not ambiguous and markets have a happy knack of looking through commentary. The economy is fine. The interest rate environment in the UK is benign. Indeed a case could be made for further cuts but this is not going to happen. Interest rate increases however are not on the immediate horizon. The Bank of England is itching to raise interest rates and is constantly arguing its case through the usual channels (see my blog post Bank of England Inflation Reports: track record). The worst is going to be a small interest rate increase and then a very gradual path. It is likely that any such initiative will follow the US Federal Reserve, which is even more trigger happy. If the Fed take into account the strength of the US Dollar even this institution will struggle to justify an interest rate increase.

Can the UK election change this dynamic? It would seem not. It will be either a Conservative led government or Labour led government. The outlook for London housing is worse under a Labour administration but it is hard to finesse much net macroeconomic difference. Under a Labour administration an EU referendum is not on the cards and this is an important consideration. One of the most important developments has been in currency movements and this is also subject to some daft commentary which can be misleading.

GBP EUR daily

The above chart shows how many euros you get per unit of sterling. Sterling has strengthened enormously against the euro in the last year. It has also strengthened somewhat against the Yen. Below is a chart of GBP USD. It shows how many US dollars you get per unit of sterling. Sterling has weakened dramatically against the USD. So when the press speak of sterling strength and weakness you should ask vis-a-vis what? Strictly speaking the reference should be for sterling against a basket of currencies but then we have the debate on how to construct such a basket (it is not obvious). The reality is that sterling as such has done very little. The Yen and euro have weakened and the US Dollar has strengthened. Sterling has been caught in the wash as it is really not that important anymore, except to us. It is unlikely to be a big factor in the BoE interest deliberations given this pattern of outcomes.

GBP USD daily

It should however be an important consideration to UK equity investors if they venture into foreign markets. If you invested in the UK markets unhedged you would have benefitted from sterling weakness as your US gains translated into sterling would have gained from sterling weakness. If you had invested in european equities unhedged the dramatic gains would have been largely offset by the equally dramatic decline of the euro. Do you know the hedging policy of the funds you have your pension, ISA or general investments invested in? No? I thought not.

Investing in UK equities does directly involve such considerations. However, indirectly it may well do so. Many of the FTSE companies are global. They generate revenue from somewhere else. They may also use parts sourced  from all over the world. Such big currency moves will have potentially large implications for the bottom line if unhedged. Do you know the hedging policy of companies in which you are invested? No? I thought not.

What is the purpose of this little diatribe? The press, bless them, look at equities and speak of the ‘economy’ as if there is a one to one correspondence between the two. They speak of politics as if uncertainty is automatically bad for equities. Yet in the last 12 months the biggest single factor determining returns may well have been currency moves which rarely get much mention in this context. Moreover, for extended periods (many years) currencies can trend despite so-called ‘fundamentals’.

You have been warned.