The Pound slips to the lowest level against the US Dollar since 1985

Jason Hollands, Managing Director of online investment service Bestinvest, comments:

"Today marks the 30^th anniversary of Black Wednesday, when the Pound crashed out of the Exchange Rate Mechanism – a system that linked European currencies as a precursor to monetary union – after the Bank of England had spent billions of reserves trying to defend the Pound. At the time it was a humiliating moment for the then Chancellor of the Exchequer, Norman Lamont, but in the aftermath the UK economy ultimately flourished, in large part due to having greater control over monetary policy outside of the constraints of ERM and monetary union.

"It's ironic that on such an anniversary, the Pound has now dipped to $1.14 versus the US Dollar - a level last seen way back in early 1985. There are of course a variety of factors that drive exchange rates and this year has seen the Dollar strengthen significantly versus the Pound, the Euro and the Yen as the US Federal Reserve has been more aggressive in front loading its interest rate hikes than other central banks and is less exposed to the impact of high energy prices than European economies.

"Currency weakness is a double-edged sword. It is clearly bad news for anyone planning to visit the US in the near future and it adds to inflation pressures in so far as it pushes up the cost of imports on goods or commodities priced in Dollars e.g. oil. However, on the flip side it can make some domestic exporters more competitive internationally.

"For investors, the weakness of the Pound is something they need to be acutely aware of at the moment. For UK-based investors, the strengthening of the Dollar has helped mask underlying losses on US shares and global equity funds this year. While the S&P 500 Index of large companies has declined in capital terms by -18% since the start of the year (to 15/9/22), in Pound terms the decline has been just -3.5% because gains made on the Dollar have helped offset share price declines.

"But for those thinking of adding to their investments, care needs to be taken about using much weakened Pounds to purchase still relatively expensive US shares. While the Dollar may well climb even higher in the near term, this strong trend won’t go on for ever and could reverse once the markets decide that the Fed has reached the end of its hiking cycle.

"Closer to home, UK large-cap companies that do business globally have very high Dollar earnings and should not therefore be seen as a proxy for the domestic economy which is clearly facing headwinds. In fact over 70% of the revenues of the FTSE 100 are made outside of the UK. As those overseas revenues – much of which are in US Dollars - are translated back into Pounds, this could boost UK reported profits and dividends.

"For those contemplating new investments with their depressed Pounds, the good news is that UK equity valuations are attractive at current levels with the FTSE 100 trading at a 12-month forward Price/Earnings multiple of 9.4 times earnings but with a 4.1% forward dividend yield. This is well below Europe ex UK (12.1 times forward P/E and 3.4% yield), the US (on a 16.9 times P/E multiple and 1.7% yield) and Japan (12x P/E multiple and 2.5% yield). UK equities continue to offer a yield premium over UK government bonds (ten year gilts are yielding 3.14%) and, by the way, older investors may remember that prior to the global financial crisis, bond yields were usually higher than those on equities.

"Boring old UK large caps have not been high on the radar of investors for many years now, lacking exposure to exciting stuff like tech and social media companies. But now might be a time for a rethink as UK large cap indices have an abundance of exposure to energy, financials and consumer staples shares. These sectors are well positioned in the current environment of high energy prices and with rising interest rates creating opportunities for margin expansion at banks. Consumer staples companies – firms that make day-to-day stuff we will buy whether the economy is in the doldrums or in rude health – should prove resilient at a time when squeezed households are having to cut down on discretionary spending."