Facebook Twitter Linked In Youtube Pinterest

The FTSE at an all-time high - great news, provided your ‘home’ currency is sterling

Written by Martin Upton

Tuesday 3rd January 2017

In a year of political turbulence, dominated by the unexpected Brexit vote in the UK in June and Donald Trump’s surprise triumph in the US presidential election in November, the FTSE-100 has had a stellar year. 
 
The benchmark index finished 2016 at an all-time closing high of 7142.8, up 14.4% from the end of 2015. The degree to which this is good news for investors hinges, though, on what their ‘home’ currency is. 
 
The sharp fall in the Pound’s foreign exchange value since the Brexit vote means that for overseas investors these gains in the sterling value of investing in UK-listed stocks are reduced or even wiped out completely when translated into the value of overseas currencies.
 
Let’s look first at the key reasons the FTSE-100 has had such a good year. There are several factors to point to but the key one is that fall in the value of the pound that following the shock outcome of the referendum on EU membership in June. 
 
Many of the firms listed on the FTSE-100 are global businesses earning substantial proportions of their income and profits in non-sterling currencies. Elsewhere other firms which have normally had a UK focus to their sales may now have greater scope to boost exports since a weaker pound makes their goods and services more price competitive. 
 
The fall in the value of the pound means that these earnings denominated in foreign currencies are now being ‘translated’ back into higher earnings and profits in sterling terms. This boosts the value of these companies when measured in sterling terms, thereby pushing up their share prices in the UK equity markets.
 
Another reason for the strong performance of the FTSE-100 relates to the search for yield by investors. With interest rates and bond yields at record lows in 2016 investors have been drawn to the equity markets in the hope that the combination of share price growth and dividend yield will prove more lucrative.
 
A further reason for the strong performance of the FTSE-100 is the recent pick-up in price inflation and the expectation that this will rise further in 2017. The relationship between price inflation and share prices is complex and much debated - particularly as there is always uncertainty about how robustly central banks will use policy measures, like higher official rates of interest, to contain the growth of inflation. However modest price inflation is usually seen as positive news for equity markets as it helps to push up the nominal value of earnings.
 
Finally the expectation that tax cuts will be initiated by Donald Trump, when he takes office, have given equity markets a fillip. Such moves would be likely to boost economic activity - although they do not represent good news to those who would like to see a reduction in the US budget deficit.
 
But, as mentioned earlier, whilst the surge in the value of the FTSE-100 in 2016 appears to be good news for investors we do need to ask the question about what their ‘home’ currency is. An investor’s home currency is that for the country in which they are resident and which they generally conduct their financial business. For sterling based investors the rise in the FTSE in 2016 amounts to that gain of 14.4% over the year. 
 
But for US based investors that gain, when translated back into US dollars via the weaker value of sterling in 2016, turns into a loss of circa 4%. For euro-based investors the outcome is close to no growth in the euro value of investing in the FTSE-100. All this, of course, is a good lesson in the need for internationally active investors to be alive to foreign exchange risk and the need to manage it.
 
As we move into 2017 it is reasonable to expect another lively year in the equity markets if only because the elections in Germany and France together with triggering of Article 50, which formally starts the Brexit process, auger more uncertainties. And, of course, the Trump presidency in the US is unlikely to be a bland affair! Another eventful year awaits investors!
 
Best wishes for 2017.
 
*Martin Upton is Director of the True Potential Centre for the Public Understanding of Finance (True Potential PUFin)
 
              

blog comments powered by Disqus