The pound has fallen hard since the start of the year.
It started 2013 at around $1.63; it’s now hovering around the $1.50 mark.
Yet it looks very much like it could have further to fall. Britain’s government seems to be all out of ideas on how to boost growth. Instead, George Osborne would rather dump the hard work on the central bank.
And there’s only one thing a central banker can do in these circumstances.
Trash the currency…
Britain’s business model is broken, and no one is trying to fix it
Chancellor George Osborne isn’t backing down, reports the FT this morning.
As far as he’s concerned, he’s sticking to his plan. There’ll be ‘fiscal discipline’, combined with slack monetary policy. The idea is that easy money from the central bank will offset the squeeze from the government.
Now, you’ll hear lots of wailing about how awful austerity is for the economy. About how the chancellor should reverse course and boost growth by borrowing more money – after all, it’s so cheap right now.
This is all rubbish. It’s a false debate. Britain’s problems are structural. We’ve relied too much on banks and the housing market. The tax take from that fuelled expansion by the state. The banks went bust. The housing market is being propped up for political reasons. The tax take is down. In other words, Britain’s business model is broken, and we need a new one.
But the only strategy the government and the opposition have is to try to return to the days of the boom. ‘Austerity’ as it currently works, is designed – at best – to trim our deficit and keep markets from selling our debt en masse. Loose monetary policy is meant to boost inflation, and help the banks get back to square one, so that the days of easy lending and cheap mortgages can return.
So Bank of England monetary policy is only going to get more inflationary. And that means more bad news for sterling.
Get exposure to non-sterling assets
So how can you protect yourself, and even benefit from a weaker pound? If you like the idea of having a punt on the pound, you could take out a spread bet. But I’d be wary of doing it today. The Bank may well announce more quantitative easing (QE). I think it’s quite likely.
But if it doesn’t, the pound will probably rebound quite strongly. So a short-term bet is nothing more than a pure gamble on what mood Sir Mervyn King is in today. (If you are still interested in spread betting, you can sign up for our free trading email, MoneyWeek Trader.)
In the longer run however, I can see sterling falling a good bit further from here. So I’d continue to recommend that you diversify your portfolio in currency terms.
For example, I was looking at the performance of Japan’s Nikkei 225 since the start of the year. In yen terms, it’s up about 11%.
Now, we all know that one of the key drivers of Japan’s recent comeback, is the fact that the government has all but said that the yen is toast. The currency has weakened from 77 to the dollar last year, to around 94 now.
So we’ve been asking ourselves if you should hedge your currency exposure or not. If you hedge the currency (ie get full exposure to Japan in yen terms), you’ll get the full benefit if any further yen weakness boosts stocks further. But if the yen strengthens, and stocks fall, you’ll be exposed to the full pain of that too.
But if you’re a sterling investor, the question might not matter that much anyway. If you look at the Nikkei in sterling terms, since the start of the year, it’s also up by 10% – pretty much the same, in other words. That’s because the pound has been such a duffer of the currency this year, that it’s roughly matched the yen’s decline.
My point is, if you agree that sterling – for now at least – looks like the lame duck of the foreign exchange world, then as long as you buy cheap overseas assets, any gains you make shouldn’t be too badly hit by currency effects. Indeed, in many cases, the currency impact will boost your returns.
That’s why I’d be happy to have exposure to cheap stocks denominated in euros. I still like the look of Italian stocks (yes, Italian politics are ridiculous, but name me a time when they weren’t). But you could opt for something more diversified. We’ve tipped the Montanaro European Smaller Companies Trust (LSE: MTE) in the past.
I also still like blue-chips with US dollar exposure. Yes they’re a bit dull, and the whole ‘safety first’ trade has been done to death. But look at GlaxoSmithKline (LSE: GSK) for example (I own this stock, for full disclosure). In terms of its share price, it’s got to be a contender for one of the dullest stocks in the FTSE 100 over the past five years. But with a big chunk of its revenues in US dollars, and still paying a dividend yield of more than 5%, I can’t see any good reason not to hang on to it. There are plenty of others like it in the main index.
And my colleague Phil Oakley threw another interesting idea at me across the desk the other day – US inflation-protected government bonds (Tips). We don’t like traditional government bonds, for reasons we’ve made pretty clear (if inflation take off, and QE stops, they’ll be hammered). But if you can get an inflation-protected bond, that’s very different. You get the protection for when inflation takes off, and you also get the kicker of the strengthening US dollar behind it. I’ll be getting Phil to write up the idea for a future piece in MoneyWeek magazine (do subscribe if you haven’t already – you can get your first three issues free, so you’ve nothing to lose by trying it).
I’ll not forget gold, of course. We see gold as insurance – you hold 10% of your portfolio in it (so when you rebalance, you sell some if it’s above that, and you buy some if it’s below that). Gold has had a pretty poor year so far amid the euphoria – it’s down about 6% in US dollar terms. Yet again, the weakness of sterling means that for a British investor, it’s flat, not down.
On gold by the way, keep an eye out for an email hitting your inbox this weekend. It’s from our gold expert Simon Popple – he’s been digging through the data and reckons he’s found an interesting story in the gold market. You can see what he’s dug up on Saturday afternoon.
• This article is taken from the free investment email Money Morning. Sign up to Money Morning here.
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