Why is the Pound Getting Pounded?

Sungarden Investment Research Article of the Week

by Rob Isbitts, Sungarden Investment Research

This week’s blog borrows its title from one of the early anthems of the 1970s Punk Rock era. At a time when terrorism dominates the global newswire, another part of the world is erupting in what could become a market-moving chain of events. This is accompanied by an atmosphere that can appropriately be described as vicious (Baby Boomer alternative music buffs from their college days hopefully get the pun there).

What is going on?

• Scotland has tired of what they consider second-class treatment by the British government and is threatening to leave the United Kingdom.

• The Scottish people seem to be divided – some want to continue being part of the U.K. and others want to break off into an autonomous nation

• The former group feels a sense of loyalty and history, and also sees that independence may not be all it is cracked up to be. They are concerned that what they gain from autonomy will be more than offset by potential economic isolation and a long battle for legitimacy, which they don’t have as part of the U.K. system. Scotland currently makes up about 1/10 of the U.K. economy.

• The latter group feels that despite recent concessions by the U.K. government, they are better off fending for themselves.

How has this impacted the financial markets? The U.K.’s currency, the British Pound, has been…er, pounded…the past couple of weeks. This has had a direct impact on British stocks. While many are large, diversified global businesses, their profits ultimately come back into Pounds and so a decline in the Pound is a negative for them.

At Sungarden, we invest in the stock market in a “bottom-up” fashion. That means we are far more focused on selecting businesses we like than “top-down” money managers who start with a strategy to own certain types of stocks (by industry, sector, country) and secondarily select stocks within their desired allocation to those broader factors. And while we do have self-imposed limits on how much we will allocate to market sectors and such, the limits are intentionally kept fairly wide. We happen to own some of those global companies based in the U.K., and so we have seen what at this point is a very minor impact on our portfolio returns.

So far, this looks like the latest in an unending series of trader-driven, emotional market events that will be largely forgotten soon. But just in case it is not, we do want our clients to know we are following the Scottish situation closely. As always, we are prepared to adjust things quickly if we reach the point where we feel a more material negative impact on our portfolios is possible. To be clear, we feel we are nowhere near that level of concern currently.

Next Thursday, September 18 is a big day in the “Scottish skirmish.” That day, the Scots vote on the issue of independence. As Axel Merk of Merk Investments, (who we consider the “Prime Minister” of currency management) stated in a recent commentary, the vote has been on the calendar for a while. What caused the recent market worry is a poll that shows the vote could be very close. That is surprising to a market that has been so fat and happy for so long that any bad news can have an outsized impact. Merk reports the following:

That same poll that suggested Scots will vote for independence also suggested 44% of Scots believe Scotland would be worse off economically as an independent country (vs 35% thinking Scotland would be better off); similarly, 41% of Scots thought they would be personally worse off with Scotland as an independent country (21% thought they would be better off). To me this suggests a proud Scot may well indicate in a poll that they favor independence, but it doesn’t mean they’ll vote that way.

And you thought the new Royal pregnancy was the only big news from across the pond this week!