Since the EU referendum on 23 June, the pound has plunged in value versus the dollar by around 17%. This size of the fall in such a short period of time is highly unusual, but isn’t entirely unexpected. After all, the UK faces perhaps its most uncertain period both politically and economically for many years. However, it could work to the advantage of long-term UK investors.
In the short run, one of the main effects of a weaker pound will be inflation. Imported goods will become increasingly expensive and higher costs for businesses are likely to be passed on to consumers. Clearly, UK consumers are concerned about what this will mean for the affordability of their goods and services. Inflation has already crept up to 1% since the referendum and is very likely to move higher.
However, the amount by which prices will rise could prove to be lower than anticipated. In other words, inflation may not move to an excessively high level. That’s due mainly to a continued deflationary cycle across the world economy. In the US, inflation is still relatively low and China’s GDP growth rate is set to slow in the coming years. Therefore, central banks are somewhat nervous about raising interest rates across the developed world for fear of encouraging deflation to take hold rather than being worried about inflation.
As such, UK interest rates may be kept low or moved even lower in the coming months. This has the potential to stimulate the UK economy since exporters will become increasingly competitive on price versus their foreign peers. Therefore, investing in UK companies that have operations abroad (which a large number of listed companies do) could prove to be a sound move over the medium term.
UK exposure
Such companies sometimes have very little exposure to the UK economy. This could help to protect investors from potential weakness in the UK economic performance in the short run. A number of FTSE 100 stocks may report in sterling but their operations are focused abroad. Therefore, they’re currently gaining from a positive currency translation, which is set to continue. This could be an opportunity for investors to buy them ahead of further weakness in the pound.
Of course, the pound is weaker because confidence in the UK economy has deteriorated in recent months. In other words, a weaker pound mirrors the outlook for the UK economy. In the short run, it could encounter difficulties such as higher unemployment and slower GDP growth as the Brexit effect takes hold. In turn, this may harm the financial performance of UK-focused retailers, banks and other companies that are reliant on the UK for most of their earnings.
However, this situation offers the chance for long-term investors to buy such companies while they trade at a discount. This wider margin of safety could equate to higher long-term gains and make Brexit and a weaker pound the best buying opportunity for a number of years.