Three stocks to prosper from a weak pound

With the next year looking bleak for the UK economy, sterling looks set for a bad year. So what can you buy to take advantage? Theo Casey tips three stocks that should rise as the pound falls.

In the next 12 months, sterling could really suffer against the dollar. While the US economy is far from perfect, the dollar at least has fundamental valuation on its side. The trade weighted price is 25% below its historic average.

The dollar also looks to have traders on its side. Net speculative positions (the ratio of buyers versus sellers of the dollar) have turned positive for the first time since May last year. That's a sign that feelings towards the greenback have stopped getting worse.

Credit Suisse believes it will fall to somewhere around $1.38 per pound. That's around 17% lower than today. This is because, of all the triple-A economies, the UK has the highest chance of a government debt crisis.

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Why? Four main reasons

Our budget deficit is worse than any other OECD country;

The stimulus is nearly over, with 95% of the QE already spent;

Inflation expectations are significantly worse than rivals;

And, a weak government (or potentially hung parliament) would be impotent to bring about fiscal change.

But the list goes on

There's also our consumer indebtedness, where household liabilities are 155% of disposable income, compared with a still terrible 128% in the US. And then there is our expensive housing market to consider. According to the IMF, UK houses are 20% above the world average, while US housing is 10% below average.

The next 12 months are unlikely to be as progressive as the last. In 2009, the pound appreciated 6% against the euro and 10% against the dollar. With the UK's bleak fiscal and monetary picture, plus our stuttering return to economic growth, we could be set for a bad year for sterling.

But what could you buy to avoid the same fate as our currency?

Three stocks to prosper from a weak pound

Go for stocks with large, reliable foreign income. For example

Diageo (LSE: DGE): This FTSE constituent is a clear beneficiary of a strong dollar. A 10% rise in the dollar would imply about a 5% rise in the Guinness manufacturer's earnings. The company makes 42% of its revenue in dollars or in dollar-linked currencies. Couple this with the company's cost savings program and the fact that it trades at a discount to Pernod Richard and Remy, Diageo is a good pick.

National Grid (LSE: NG): The name is a misnomer Nat Grid earns exactly half its money in the States. And it's not just on the profit and loss statement that this company wins from a weak pound, it's on the balance sheet too. National Grid asset base in the US is boosted by a rise in the dollar because the accounts are denominated in pounds. As a company, it's a utility stock with little competition and little exposure to falling energy prices and it is expected to raise tariffs in the US. All the more reason to add it to your watchlist.

Sage (LSE: SGE): Two fifths of revenue and one third of profits are in dollars here. The stock trades at a 25% discount to the global software sector and the core business of accounting software is as stable as it always has been. Another plus is the cash flow, after all cash in the bank is what every company strives to achieve. Sage's free cash flow, the amount of cash left over after the company has paid all its expenses and what was spent for capital expenditures (reinvested into the company), is the best in the sector.

Given the political and financial backdrop, it's difficult to buy sterling. Maybe that's why nobody is. Unlike with the dollar, speculators in the futures market have not had a net long position in sterling for nearly a year and a half!

Thankfully, by holding stocks like Diageo, National Grid and Sage, you have an opportunity to shield your wealth in 2010. And, because they're undervalued opportunities, even if the pound doesn't fall, these stocks should rise.

This article was written by Theo Casey, investment director of the Fleet Street Letter , and was first published in the free daily investment email The Right Side on 20 Janaury 2010.