How should investors respond to a falling pound and the prospect of a no deal Brexit?
With the possibility of a no deal Brexit worrying policymakers, the value of the pound falling and the Bank of England facing some criticism for its decision to raise interest rates, Quilter Investors portfolio manager Hinesh Patel analyses the outlooks for markets and highlights some key considerations for investors thinking about how to respond to the current climate:
“Following the vote to leave the European Union the pound fell sharply on the back of significant uncertainty over Britain’s future economic outlook. Through the course of 2017, the position stabilised but the tables have turned again in 2018, with the possibility of a no-deal Brexit becoming more likely and markets subsequently discounting the value of Sterling once again.
“This is clearly troubling Mark Carney, who has gone to great length to point out the risks of a no-deal Brexit. He is evidently concerned that in the event of a disorderly exit from the European Union, the UK economy will take a hit and Sterling will fall, making the job of the Monetary Policy Committee very difficult. It could potentially even put QE back on the cards if the Bank of England felt the economy needed a boost to counter any post-Brexit malaise.
“But at the same time, if a clean resolution can be found then there is every chance of a rebounding economy needing to be kept in check by further rate rises. Interest rates could rise quickly, perhaps with as many as five hikes in 18 months, taking the base rate to 2%.
“A key factor in all this is the strengthening of the US dollar, which has picked up a head of steam from a resurgent economy. The weakness of the pound is exacerbated by the strength of the dollar, impacting the cost of key imports that trade in the US currency. If Sterling continues to weaken relative to the dollar it could create inflationary pressures by pushing up the cost of imported goods, creating a potential catch 22 for Mark Carney.
“The Bank of England really face a conundrum where a binary event like Brexit will have a dramatic impact on their forecasts and expectations. Normally Central Banks are expected to gradually tweak the dials to keep equilibrium in the economy, but the binary nature of the Brexit negotiations makes that very challenging.
“For investors feeling circumspect about how all of this might impact them, it is really important to keep a rational perspective. There are a few key things to remember amid the current economic uncertainty:
- “A weaker currency can be a plus for investors in the UK since the largest names in the FTSE 100 in particular have a very international outlook, and actually benefit from a weaker Pound because so many of their revenues are earned overseas in currencies that are correspondingly stronger. Likewise, it can boost exporters, who benefit from the fact that goods shipped-out from the UK look more appealing to global trading partners.”
- “Although stable political and economic conditions are typically beneficial over the long-term, they are not the be all and end all. Investment markets can thrive in spite of these things. The flourishing US stock market over the last year has been a good example of strong performance despite the political incohesion caused by an unpredictable President.”
- “Risks affecting a particular region are precisely why it is important to diversify your investments. It is common for investors to hold a ‘home bias’ and invest more in their domestic stock market. If you’re only holding a UK tracker fund, for example, then you have total directional risk to UK companies. A diversified portfolio, in contrast, will give you the opportunity to benefit from growth elsewhere and guards against the chance that one region throws your investments off track.”
- “Active fund managers have the flexibility to increase or decrease exposure to particular assets and plan ahead by hedging certain risks, like currency volatility. Although they typically charge a higher fee than passive funds, when we’re selecting managers to provide strategic exposure to particular asset classes within our own portfolios, we favour an active manager that can protect against downside risks where it is needed.”