Valuation also driving flow.

Friday, 10th August 2018 13:39 - by Shant

The theme of the week in macro-world is that of capital outflows into safety.  At the present time, the US is where the attraction is, not only in equities which continue to bump fresh highs but also Treasuries which not only act as a large pool of liquidity by offering some attractive yields as the Fed continue on their path of normalisation still.   Major losses in the currencies of Turkey, Russia and South Africa are standout in the emerging markets, with diplomatic rows with the former two sending the markets into panic mode.  As we seen with Turkey especially, the USD/Lira rate has skyrocketed through 6.0000 - double the rate it was in the first half of 2016! 

For importers, these are attractive levels to start stockpiling, and away from vehicles and machinery, Turkey experts a significant amount of textiles around the globe - close to $9bln according to records.  Precious metals are even higher at close to $11bln.  Retailers take note.  Russia also exports precious metals in similar amounts but is dwarfed by energy which accounted for over $173bln last year - liquified natural gas supplementing UK production, but much of this comes from Norway, Holland and Qatar in relative terms. 

However, we are straying from the point.  That is exchange rates and valuation.  This - as is dismissed by many pundits - is a material driver of trade in the current climate.  It has been a long held view of ours that global demand is fragile, and while recent years have seen a pick up due to the unprecedented levels of accommodative monetary policy from the major economic powers, the battle to suppress domestic currency levels suggest major trading nations are not as convinced of recent strength as is perceived.  

The phrase was - a few years back - the race to the bottom.  Ie, depressing exchange rates for competitive advantage in the trading arena.  This is nothing new.  It is however, becoming an ever more contentious issue as we have seen recently with the US administration balking at supposed manipulation from China and Europe.  Trade wars have swiftly turned into currency wars and we believe this is just the start of it.  

At the present time, this is where the UK is again gaining some benefit (though not through manipulation it has to be stressed) and hot off the release of the Q2 growth stats, were seeing business investment picking up as the Brexit hit Pound looks to be returning to the levels seen in the aftermath of the referendum in 2016.  We have often cited the strong inverse relationship with Sterling and the FTSE, which is somewhat at odds with the common narrative that the UK is set to suffer immensely post EU. It is fair to say though that economic disruption is inevitable should we part ways without some form of agreement in place with the EU.  Even so, a wholesale implosion is not on anyone's radar or expectations, and demand for UK shares when the Pound drops validates this argument.  

Earlier in the week, we highlighted the benefit in holding consumer staples over high end,  luxury and even recreational producers and service providers and this is where we continue to see not only value in our eyes, but that in foreign investors.  This is a consumer economy and there are many of 'us', which is something which has been argued as a negotiating point for the Brexit talks.  Nevertheless, as long as investment and infrastructure spending stay strong, there is every reason to counter (more so than fight) the over-bearish tide reflected in the exchange rate.

Further afield, while currency speculators push hard against all currencies against the USD, there is also the opportunity to lock in some attractive rates for UK corporates looking to deviate trade - in part at least - away from Europe.  Here, there is little exchange rate advantage to be had as the Euro vs Sterling continues to drive higher, but enterprises holding cash reserves in USDs (and there are many) can reduce import costs significantly looking further afield.  

You see, volatility can be a good thing - in a number of ways.  No?

The Writer's views are their own, not a representation of London South East's. No advice is inferred or given. If you require financial advice, please seek an Independent Financial Adviser.