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How Might Theresa May’s Demise Affect the Value of Your Investments?

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Some would say Theresa May has been a ‘zombie’ Prime Minister from the moment the results of the snap June general election she called came through. She took Britain to the polls, firm in the belief that a Labour party fractious under the leadership of a much maligned and oft mocked Jeremy Corbyn would put up little resistance. The idea was to put to bed the fact that she was not a directly elected prime minister once and for all by strengthening the Tory majority in Parliament. This would subsequently allow May to tackle Brexit negotiations from the position of having been given a clear mandate to do so and a unified party behind her.

The result, as we know, was rather different. Corbyn performed far better than expected over the course of the general election campaign, rallied Labour’s grass roots support and gained 32 additional seats in Parliament. May’s Conservatives lost 13 and their overall majority which subsequently meant that avoiding a hung parliament necessitated forging an uneasy alliance with Northern Ireland’s controversial Democratic Unionist Party. May and the Conservative Party still won the election but in reality the result was considered to be a devastating loss. The snap election, which didn’t need to happen with the next general election not due until 2020, significantly weakened the Government’s position instead of strengthening May’s hand as intended.

While May has survived the immediate aftermath of the disastrous result of a general election she called, all is not well. Floundering Brexit negotiations and a raft of resignations and scandals involving cabinet members mean that internal doubts over the continued viability of May as leader of the Conservatives, and as Prime Minister, appear to be now coming to a head. A weekend report by The Sunday Times, suggested that as many as 40 Tory MPs, only 8 short of the number required to trigger a leadership change, have signalled their readiness to sign a letter of no confidence in May.

A Brexit without a UK-EU trade deal appears to be a genuine possibility at the moment with stalemate on how much the UK must pay to amicably settle its withdrawal from the EU between the negotiating parties. An unnamed Conservative MP is reported to have told The Times “it’s a horrible thing to say . . . but we are getting closer and closer to the point whereby we need some time in opposition to regroup.”

The implosion of May’s Government and a new Conservative leader, which could well also lead to a new general election sooner rather than later, is considered to carry the real danger of leading to the UK “crashing out” of the EU, as opposed to an orderly, negotiated withdrawal. It’s a scenario which will hopefully be headed off before it happens, one way or the other. However, what that way might be is currently very opaque. As such, it makes sense for those with stocks and shares ISA investments online, or a stock market portfolio, to prepare for the eventuality and start to consider what impact May’s demise would likely have on financial markets and the wider UK economy.

Let’s take a look at what the repercussions would be expected to be and steps those investing online in stocks and shares ISAs and SIPPs might consider to fortify their portfolios against the inevitable turmoil a change in government would bring.

A Weaker Pound
The pound dropped immediately on Monday morning following the report in The Sunday Times as markets further priced in the likelihood of May’s Government unravelling. Continuing lack of clarity on Brexit, or negotiations breaking down altogether would be expected to continue to weigh on the value of the pound against major international currencies such as the dollar and euro. Whether we see a change of leadership that then sees the Tories unite behind it and continue in Government, or another general election, Brexit negotiations will be interrupted, which won’t help the pound.

What Does a Weaker Pound Mean for Investors?
Taken in isolation, a weaker pound is not necessarily a bad thing for stock market investors. We’ve already seen the boost that’s given to the London Stock Exchange, which has risen in inverse correlation to the drop in the pound’s value immediately after the Brexit referendum. Most of the biggest companies, which comprise the FTSE 100, make much of their revenue in other currencies, which boosts their bottom line when converted back into sterling. A weaker pound also means buying into UK-listed companies represents better value for investors with other base currencies and increases demand.

However, exactly how much of the London Stock Exchange’s gains over the past year and a bit can really be attributed to the reduced value of the pound is open to debate. International stock markets have been on a strong bull run over the same period and the FTSE 100 has not performed significantly better than many other leading European and U.S. benchmark indices over that period. The FTSE 250, the 250 largest companies on the LSE after the FTSE 100, and the FTSE All-Share indices have also performed equally strongly, both up around 19% to the FTSE 100’s 21% over the period. These indices are much more UK-economy focused. The pound’s drop on Monday again led to gains for the FTSE 100 but those quickly turned into losses.

While there are advantages to be gained from a weaker pound, too much has probably been read into its influence over the past year, with the majority of gains more likely the result of the wider international bull market for equities. Those investing online into their ISA or SIPP would be best advised to not put blind faith in a weakening pound meaning the UK benchmark index will continue to rise.

Diversifying currency risk within an investment portfolio could bring advantages. Increasing allocation to equities or funds denominated in dollars, euros or yen would mean that both any dividends or capital gains on sale would worth more when converted back into sterling.

Inflation protection readjustment of an investment portfolio focused on UK equities would also be something worth seriously considering. A weaker pound means imports from foodstuffs and fuel and anything else not 100% produced in the UK or using components originating in the UK becomes more expensive, driving inflation up. We’ve already seen evidence of this trend taking hold, with the inflation rate gradually increasing up to 3% in the past year and expected to rise some more.

Cash allocation within an online investment portfolio should be kept in money market funds during periods of high inflation. The rates they pay are adjusted upwards with inflation as interest rates are hiked to combat rising inflation.

Longer-term fixed-interest assets such as bonds perform historically perform poorly when inflation rates are higher. As investors chase higher-yielding alternatives, bonds tend to lose value. As such, investors should consider reducing portfolio allocation to long-term bonds.

Equities are generally a good investment class when inflation increases as businesses pass rising prices on to their customers. However, growth equities tend to perform better than income equities when inflation rises as shares which pay high dividends suffer the same way as bonds.

Sectors which tend to benefit from inflation, such as energy, food, healthcare, building materials and technology, where prices rise, should also be given priority.

Commodities are another asset class that more often than not does well when inflation picks up. They are also internationally-facing and commodity prices are not tied to the UK economy. Increasing exposure to precious metals and energy commodities either through commodity-based ETFs or equities closely correlated to these commodities, such as miners and oil and gas companies is another portfolio adjustment to consider.

Finally, real estate-backed assets, either through direct ownership of investment properties or via funds and REITs typically perform well in a higher inflation environment. Rising rents encourage ownership and often boost property values, which can see their greatest gains when inflation is high.

However, right now UK investors should be wary of real estate as prices are already very high and significant price growth isn’t predicted for the next few years. European companies, or other foreign companies based in the UK for access to the EU market may start to leave, which could hit the commercial property market. It is also important to look at the debt levels of companies which offer exposure to real estate as servicing debt will become more expensive if, as expected, interest rates rise to combat inflation.

Conclusion
Whether May stays or goes, Brexit turmoil is likely to mean that we can expect a pound well below pre-Brexit levels, meaning much of what has been covered remains relevant. However, May’s Government falling apart and a messy Brexit resulting, or just a messy period on the way to improved negotiations, will probably push the pound lower and intensify these influences. Investors should start considering any necessary adjustments to their online investments portfolio from now, while keeping a close eye on developments.

Risk Warning:

Please remember that financial investments may rise or fall and past performance does not guarantee future performance in respect of income or capital growth; you may not get back the amount you invested.

There is no obligation to purchase anything but, if you decide to do so, you are strongly advised to consult a professional adviser before making any investment decisions.

Paul

The author Paul