Why stockmarkets rise when currencies fall – explained in two charts

These two charts help explain why the FTSE 100 can rise when sterling falls.

03-15-2017
Market-analysis-ipad

Authors

David Brett
Investment Writer

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

How-indexes-rise-when-currencies-fall-ftse-v-sterling

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.

FTSE-100-Exposure-by-geographic-revenue


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.

The views and opinions contained herein are those of Schroders’ investment teams and/or Economics Group, and do not necessarily represent Schroder Investment Management North America Inc.’s house views. These views are subject to change. This information is intended to be for information purposes only and it is not intended as promotional material in any respect.

Authors

David Brett
Investment Writer

Topics

Equities
UK
Foreign Exchange
David Brett

Please consider a fund's investment objectives, risks, charges and expenses carefully before investing. The Schroder mutual funds (the “Funds”) are distributed by The Hartford Funds, a member of FINRA. To obtain product risk and other information on any Schroders Fund, please click the following link. Read the prospectus carefully before investing. To obtain any further information call your financial advisor or call The Hartford Funds at 1-800-456-7526 for Individual Investors.  The Hartford Funds is not an affiliate of Schroders plc.

Schroder Investment Management North America Inc. (“SIMNA”) is an SEC registered investment adviser, CRD Number 105820, providing asset management products and services to clients in the US and registered as a Portfolio Manager with the securities regulatory authorities in Canada.  Schroder Fund Advisors LLC (“SFA”) is a wholly-owned subsidiary of SIMNA Inc. and is registered as a limited purpose broker-dealer with FINRA and as an Exempt Market Dealer with the securities regulatory authorities in Canada.  SFA markets certain investment vehicles for which other Schroders entities are investment advisers.”

Schroders Capital is the private markets investment division of Schroders plc. Schroders Capital Management (US) Inc. (‘Schroders Capital US’) is registered as an investment adviser with the US Securities and Exchange Commission (SEC).It provides asset management products and services to clients in the United States and Canada.For more information, visit www.schroderscapital.com

SIMNA, SFA and Schroders Capital are wholly owned subsidiaries of Schroders plc.