Why the Pound is plummeting but the FTSE taking off – #Brexit

Why is it that, despite a weakening currency has the stock market has gone up? What does it mean for me? Is it good or bad? – Read on to find out.

Is anyone else confused? 

After #Brexit the British economy was predicted to plummet, but the FTSE (UK’s primary stock exchange or market) is hitting record highs. Similarly, in South Africa the JSE has shown excellent returns, despite what many consider a floundering economy and a currency generally on the downward trend. While much of the pain of Brexit is yet to be felt (and yes it is going to be very painful), it is also an opportunity, potentially a great opportunity.

Why does this happen?

The stock market is a complex interaction of numerous forces. But broadly two relevant buckets emerge to influence the market price; Emotions (Sentiment – are people expecting good or bad times ahead) to Reality (Fundamentals – how well each company is doing). Sentiment tends to dominate more in the short run with herd mentality and fundamentals in the long run, or put far more eloquently:

“In the short run, the market is a voting machine but in the long run, it is a weighing machine.”

Benjamin Graham (Mentor to Warren Buffett and “father” of value* investing).

But sentiment is generally down, so markets (FTSE) should be down. Yet, it has spiked, this is partly because the market hates uncertainty, so in the lead up to the Vote there was a dramatic drop. So some of what is being noticed is the rebound of this. But the more key factor is because many of the UK companies receive a large portion of their revenue from outside of the country this percentage is very high at around 60% (Second only to South Africa ~70%+).

So simplistically, if the companies before #Brexit got £100 from the UK and £100 ($130) from the US, where £1=$1.30. Now the expectation or sentiment in the UK is that due to Brexit the £100 will drop to £90 as the economy slows. At the same time the pound has weakened, so £1=$1.10. Assuming the offshore revenue of $130 stays the same, we are left with £90 from the UK and £118 ($130) from the US.

Pre Brexit – £100 + £100 ($130) = £200

Post Brexit – £90 + £118 ($130) = £208

So the foreign earnings are impacting more than the sentiment and the declining Pound. So, if the key is that the value of the pound is falling….

…why is the pound falling?

Simply the demand for Pounds is falling (and supply increasing), so they are being sold, with more being sold the price goes down. This is driven by the uncertainty of how the British Economy will look in the future.

This is all very interesting (cough cough), but….

…what does this mean for me?

Simply the market rewards risk. So the more the risk, the more the expected return. The UK will typically give a more secure, but lower return than South Africa for example. But when things are volatile (“uncertain”), this risk-return relationship breaks down.

As the currency plummets, it makes locally produced goods and foreign earnings better value in local terms, increasing exports and local consumption. But imported goods become more expensive, so great news for local productivity. At least in the short run. As time goes by, foreign investment reduces, because the weaker pound will mean they get less in terms of their own currency.

So prices in grocery stores are going to rise (see Marmitegate), historically the UK has been protected from price increase pressures because of a strong pound. In short, if you live in the UK, expect price increases as the cost of imports rises. wages rise and foreign investment decreases. Perhaps in the long run it may become even more attractive as it becomes more independent (agile?), this would have to be carefully managed and balanced against the medium term impact, because until the UK negotiates out of the EU, it cannot “officially” begin negotiating with other countries.

How it will impact you is dependent on your own circumstances and how the negotiations develop.

Good for:

  • British Tourism – A weaker pound makes the UK a more attractively priced destination
  • British Producers – They become more competitive internationally and do not compete directly with European producers internally
  • Jobs and Wages – The expected reduction in immigration should result in less competition for jobs
  • Property Buyers – With lower demand (although much of the demand comes from outside of Europe)
  • Economy – Longer term economic agility (7-15 years)

Bad for:

  • Travel abroad – Declining pound makes it more expensive
  • British Producers – Some may not, but many will have reduced access to the “Single Market”
  • Jobs and wages – Less foreign investment will result in fewer jobs
  • Economy – Medium term economic agility as the Brexit is negotiated (2-7 years)
  • Consumers – Anything produced abroad will be more expensive (losing some of the tariff free goods and declining value of Pound)
  • Energy – The UK is a net importer
  • Foreign investment – Decline in Pound reduces relative amount earned
  • Brain drain – Many skilled people and economic contributors may leave (balanced against being able to allow immigration on specific needs on the country, this will depend on the perceived attractiveness of the UK as a place to live)

Good or bad – Dependent on what happens

  • Many multi-nationals have their European Head Quarters in the UK. These could move to cities like Frankfurt, Dublin and Paris (to name a few).
  • It is very unlikely companies will pull their listing from London. So the FTSE is likely to remain diversified in the future.
  • With access to the “single market” comes the corresponding burdensome legislation, which may not meet the needs of the industry, so Brexit could make the UK more agile.
  • The UK (as a member of the EU) relies on trade deals (often very favourable) to be negotiated by the EU. It may have more flexible access to countries like China, South Africa, Canada and Australia.
  • There are many versions of Brexit, it’s a negotiation, so expect compromises, sacrifices and some stakeholders are going to be unhappy.

IN SUMMARY. THE STOCK MARKET HAS GONE UP BECAUSE OF FOREIGN EARNINGS EARNED BY THE LISTED COMPANIES. PRICES IN SHOPS WILL RISE IN THE SHORT AND MEDIUM TERM. IT IS LIKELY TO BE “PAINFUL” IN THE SHORT TO MEDIUM TERM AND IT WILL DEPEND ON HOW THE UK TAKES (OR DOESN’T) ADVANTAGE OF IT’S NEW ECONOMY “AGILITY”.

If you are looking for Global Exposure and Risk Management, check out this blog posting.

*Look out for a blog post on Speculating vs Value Investing. I think too many people use speculating and investing inter-changeably.

Economic interactions are far too complex to be summed up in a few paragraphs. The purpose of this blog post is to give insight and understanding. So certain aspects have been generalised to reduce distraction by complication. 

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