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Colin McLean: it's not too late - the pound weakness opportunity

by Colin McLean on Feb 19, 2013 at 07:58

Colin McLean: it's not too late - the pound weakness opportunity

The risk of a sharp fall in sterling this year is gaining credibility.

A continuing trade deficit, combined with declining North Sea oil production, poses a big challenge and politicians might even encourage a weaker pound to restore competitiveness and revive the UK economy.

That worked immediately after the 2008 financial crisis – this time round, devaluation might not be so readily controlled. Yet so far, the market reaction has been surprisingly muted. Why is it that currencies are so difficult to factor in to investment strategies?

Psychology is certainly at work; many analysts are good with company data, but uncomfortable with currencies. It seems easier to work with the known numbers, rather than a new environment. Behavioural finance recognises this tendency to lock on to the status quo as anchoring.

The timescale for forecasting exchange rates and incorporating them into earnings forecasts does not match the normal company results cycle. Whether companies have overseas earnings, or are exporters or importers, the impact of currency is complex.

Retail strength

Much depends on pricing power and how global the input costs are. It is not always easy to identify the location of the ultimate customer. Since this may take further meetings with the company to determine, it is easy to see why analysts are reluctant to incorporate potential currency moves. It is simply a break with the normal routine.

Why mix up detailed analysis of company numbers, with macroeconomic guesswork?

The recent strength of domestic UK businesses, such as retailers and other consumer sectors, suggests a much lower pound is not yet in market thinking.

A devaluation would squeeze consumers, reversing last year’s pick-up in spending power.

Certainly, a few retailers are being helped by lower competition, but it will be a tough environment for some of the big national chains. Earnings for the general retail sector correlate strongly with the level of sterling, albeit with a delay.

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