After sharp risk-off moves following the UK’s Brexit vote this June, UK equities experienced a dramatic turnaround over the summer.
The FTSE 100 has rallied by more than 15 per cent since its post-referendum nadir, largely as sterling depreciation has boosted the value of the index’s foreign earnings. Perhaps more surprisingly, the domestically focused FTSE 250 has rallied by more than 20 per cent, confounding expectations – for now – that a vote to leave would result in a blow to economic confidence and lead to a slowdown in UK growth.
But Brexit is only one of the political risks facing UK stocks this year. While the UK’s domestic political turmoil remains the primary focus for UK investors, the upcoming US presidential election is also an important consideration.
About 75 per cent of FTSE 100 earnings are denominated in US dollars, making the outcome of the Hillary Clinton versus Donald Trump circus and the resultant impact on the US dollar a key question for UK investors.
If anything, Brexit has accentuated this factor, with UK large caps having essentially become a glorified currency play, much as the Japanese market did with the advent of Abenomics. The outlook for the US dollar, and the role the US election plays in this, is essential to bear in mind when considering the potential for UK equities.
Higher yields and the prospect of tighter monetary policy have supported this, particularly with policy so loose elsewhere.
However, we might see the dollar reverse some of these gains in the aftermath of the result – irrespective of who wins the presidency. A Clinton victory would likely lead to some consolidation, as markets priced in the immediate consequences.
Over the medium to long term, however, we would likely see further dollar strength, with the potential for more supportive fiscal policy to boost the economy and strengthen the case for tightening monetary policy. This would help to boost the US dollar against sterling, particularly if UK fundamentals weakened.
Yet if Mrs Clinton is the continuity candidate for dollar strength, Mr Trump is quite possibly its short-term nemesis. It is hard to see how the dollar would not sell off in reaction to a Trump win, with his nativist sentiment and economic isolationism clearly detrimental to the US economy.
As the chart shows, the FTSE 100 has been broadly flat in dollar terms post-Brexit, with the gains since June 23 having come about because of the depreciation in sterling. Yet in the event of a Trump victory, UK investors would risk being on the losing side of a dollar-sterling battle for the ugliest currency award.
While weaker sterling (and higher UK inflation) would undermine support for the domestically exposed FTSE 250, sterling strength would undermine the gains UK investors in the FTSE 100 have seen so far.
As a result of the better outlook for the dollar, a Clinton presidency would likely be beneficial for UK large caps. More widely, a Democrat victory would also represent a broad continuation of the US’s global role. This would also be supportive for internationally exposed UK companies, particularly those with emerging market exposure, which rely on the relative openness on the international system.
