Why stockmarkets rise when currencies fall – explained in two charts
These two charts help explain why the FTSE 100 can rise when sterling falls.
The FTSE 100's strong recovery after the Brexit verdict in last June's referendum caught some investors off guard.
After an initial wobble, the index surged. Three months later, it was 10.4% higher. But why?
Other factors may have been at play in those months, but one of the strongest drivers in the fortunes of the FTSE was the performance of the pound.
This is because such a large proportion of profits for FTSE 100 companies is made in dollars. If sterling weakens then dollar revenues, once converted back into sterling, are worth more.
In three months when the FTSE 100 rose 10.4%, the pound fell 12.8% against the dollar.
How the FTSE 100 has risen as sterling has fallen
Source: Schroders. Bloomberg data as at 13/03/2017, showing the FTSE 100 and sterling versus US dollar.. For information purposes only. The material is not intended to provide advice of any kind. Information herein is believed to be reliable but Schroders does not warrant its completeness or accuracy. Past performance is not a guide to future performance and may not be repeated. There can be no guarantee as to the magnitude of any future market movements.
This effect has become more pronounced given the sheer volume of profits earned overseas.
As the chart below shows, 71% of revenues generated by FTSE 100 companies come from outside the UK. The strength of sterling against the euro is also important given the large chunks of revenue accounted for by France, Germany, Italy and other eurozone countries.
The inner ring illustrates that 97% of the companies on the FTSE 100 have registered head offices (i.e. they are domiciled) in the UK.
The outer ring is the important part. It shows the regions from which FTSE 100 companies generate their revenues. All but 28.9% are generated outside the UK.
Consider a simplified scenario of currency movement. If the exchange rate was $2 to the pound then every $1,000 of revenue would be worth £500. However, if sterling weakened and the exchange rate moved to $1.5 to the pound, then every $1000 of revenue would be worth £667. The outcome is that revenues increased 33% as a result of the fall in sterling.
Advertising firm WPP is among a number of UK-listed companies which have recently announced that their earnings have benefited from sterling weakness.
It can have the opposite effect too. Engine maker Rolls Royce recently announced that its profits were being impacted by weak sterling.
The notion that a falling currency boosts the local stockmarket applies to most markets, but the extent depends on the market's reliance on foreign revenues. The FTSE 100 is a particularly strong example of this, with the dramatic effects of Brexit underlining the point in 2016.
This communication is marketing material. The views and opinions contained herein are those of the named author(s) on this page, and may not necessarily represent views expressed or reflected in other Schroders communications, strategies or funds.
This document is intended to be for information purposes only and it is not intended as promotional material in any respect. The material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The material is not intended to provide, and should not be relied on for, accounting, legal or tax advice, or investment recommendations. Information herein is believed to be reliable but Schroder Investment Management Ltd (Schroders) does not warrant its completeness or accuracy.
The data has been sourced by Schroders and should be independently verified before further publication or use. No responsibility can be accepted for error of fact or opinion. This does not exclude or restrict any duty or liability that Schroders has to its customers under the Financial Services and Markets Act 2000 (as amended from time to time) or any other regulatory system. Reliance should not be placed on the views and information in the document when taking individual investment and/or strategic decisions.
Past Performance is not a guide to future performance. The value of investments and the income from them may go down as well as up and investors may not get back the amounts originally invested. Exchange rate changes may cause the value of any overseas investments to rise or fall.
Any sectors, securities, regions or countries shown above are for illustrative purposes only and are not to be considered a recommendation to buy or sell.
The forecasts included should not be relied upon, are not guaranteed and are provided only as at the date of issue. Our forecasts are based on our own assumptions which may change. Forecasts and assumptions may be affected by external economic or other factors.
Issued by Schroder Unit Trusts Limited, 31 Gresham Street, London, EC2V 7QA. Registered Number 4191730 England. Authorised and regulated by the Financial Conduct Authority.