UK Election Implications
As expected, the Conservative party appears to have won the UK general election, and thus will command a majority in Parliament. This now brings near certainty that the Withdrawal Agreement Bill will be passed in the next few weeks, and a “Brexit” will occur by the end of January.
In the near-term, we can expect an increase in the value of British pound, reflecting the increased clarity. While it has already rallied tremendously over the fourth quarter as the polls indicated the now confirmed election outcome, it is still at historically low levels (£1 = ca. $1.341) and remains undervalued versus the US dollar on most measures of purchasing power parity, a proxy for “fair value”. A move back towards “fair value” (ca. £1.45), would imply significant further upside.
However, let us remember that “Brexit” day at the end of January will signal just the beginning of negotiations surrounding the future relationship with the EU, not the end. Prime Minister Boris Johnson has insisted that Britain will leave the transition period just 11 months later, at the end of December 2020, with a permanent trading relationship in place with the EU. The next year may end up very like the last three, with much “noise” generated from negotiating deadlines and red lines and a clean break – or negotiated settlement – with the EU. A number of other important factors such as interest rates, inflation and general economic conditions will also impact currency movements. It is likely that Sterling volatility will persist – a sustained recovery towards “fair value” over 2020 is not our base case. Rather, we expect range-bound trading around the US$1.35-level, but as always, are humble about our – or anybody’s – ability to forecast FX with high conviction.
Our primary goal remains not to guess the direction of the currency based on unknowable future factors, but rather to ensure we are comfortable with risks to multi-asset, sterling referenced portfolios. In globally oriented strategies, sterling weakness will lead to positive performance, all else equal. Conversely, should sterling strengthen, a currency drag will occur; thus we “hedged” part of the non-Sterling exposure earlier in the year and may increase this should sterling fall notably.
However, barring currency positions, the election will not of itself impact our risk allocations; geopolitics tends to be a red herring, and thus best ignored for asset allocation purposes. Our investment process seeks to evaluate the long-term fundamentals rather than focus on short-term movements. It is deliberately long-term. It aims to eschew the “noise” which inevitably surrounds such events, and look to what we consider indelible, longstanding drivers of asset returns: economic cycle, valuation, momentum and sentiment. To the degree that geopolitical events impact the fundamentals, we pay attention. To the degree they do not, we remain positioned to take advantage of any excessively bearish sentiment by taking contrarian positions.
Over the coming weeks and months, the Kleinwort Hambros Investment Committee (KHIC) will consider if the new paradigm – where the UK moves towards full autonomy from the EU – has resulted, or will result, in a change to the underlying factors that underpin our expected future returns from various asset classes. For the moment, our portfolios remain well balanced, with diversified allocations to assets such as equities, fixed income, cash, commodities and low-volatility hedge funds.
1. As at 8:40am time on 13 December 2019
The value of investments can fall as well as rise. You may not get back what you originally invested.
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