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Evenlode Investment View - March 2010

Currency Considerations

The US dollar will take some time to shed its reserve currency status. However poor the US’s fiscal position looks on an absolute basis, relative to Japan and Europe it doesn’t look so awful. Moreover, despite a tough decade, the US dollar remains the premier franchise of the monetary world. Like Microsoft Windows, it has its glitches but it’s what people are used to - old habits die hard.

Unfortunately the British pound lost this status with the death of the British Empire. In recent weeks it has received particularly unceremonious treatment as the whipping boy of global currency markets. This is an impressive feat given recent developments in Southern Europe. With the Greek government’s global respectability hanging by a thread the whole future of the euro as a currency regime has been called into question, with no clear answers forthcoming. Add to this giant imponderable the fact that most of the large euro-area banks are up to their gunnels with the sovereign debt of Southern Europe and it is no surprise that the euro is currently proving unpopular as a store of value. But even this latest wave of euro-scepticism has not prevented the pound weakening slightly against the Euro since the start of the year, and against the dollar, the pound has fallen by more than 8%.

There are three main factors leading to this sharp depreciation of the pound. The first is Gordon Brown’s current opinion poll recovery, the political equivalent of zombie B-movie Night Of The Living Dead. Of the possible election outcomes, a hung parliament is the one that those shorting the pound would celebrate the most. Months of political wrangling and a second election are unlikely to be the answer to the UK’s deficit crisis. To regain fiscal credibility the country needs a majority party in power with a strong political mandate to make tough decisions. This looks increasingly unlikely. Second, the UK economy is lagging most others out of recession. Third, the Bank of England’s tone on monetary policy in recent weeks has been relatively dovish. In particular, Mervyn King has left the door open to further money printing, suggesting that UK base rates are a long way from moving significantly higher.

It is very British to wallow in a bit of domestic misery, and our recent wintry weather is an appropriate companion to the economic and political woes that confront us. However, current sterling weakness should be no bad thing for the British investor. If the goal of investment is, at its minimum, to preserve the real purchasing power of your capital in the currency in which your liabilities fall due (where that liability can be anything from a pint of milk to the interest on your mortgage), we have all been given a helping hand in recent weeks. As owners of companies and assets in foreign currencies, the purchasing power of our net wealth has just gone up. The UK stock market earns approximately two-thirds of its profits in foreign currencies. Given our current preference for multi-national franchise businesses , the Evenlode portfolio has an even higher exposure to global earners, as well as nearly 15% of the fund in foreign listed companies.

For historical precedent, the UK’s exit from the European Exchange Rate Mechanism in 1992 was a reputational blow for the incumbent government, but a boon for the UK stock market and ultimately the economy. Britain’s global earners and export businesses had a field day in the following months. It feels like we are in the middle of a comparable, if much less extreme and more drawn out, version of this event.

Hugh Yarrow
March 2010

Please note, this investment view contains the personal opinions of Hugh Yarrow as at 1st March 2010 and does not constitute investment advice.

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