Henderson: Snap election: short-lived sterling strength?

(Foto: Luke Newman, co-manager of the Henderson UK Absolute Return strategy)

With markets focused on geopolitical events in Korea, the US and France, the chances of a ‘snap’ general election in the UK were being overlooked by many market commentators.  The surprise announcement today led to a sharp rally in sterling and falls in UK equities. We believe this shifting backdrop presents opportunities for a long/short strategy, suited to tactical trading, such as ours.

The immediate strength in sterling following the election announcement can be explained by two conflicting theories: 

a) If the incumbent Conservative Party can win the 8th June general election convincingly, this may increase the likelihood of a ‘hard’ Brexit* outcome. Given that a ‘hard’ Brexit has so far been associated with sterling weakness, the immediate strength in sterling following this morning’s announcement may therefore seem perverse. However, the market may view a convincing general election victory as strengthening Theresa May’s hand in European Union (EU) negotiations, and therefore increase the chances of her delivering on her stated objectives, such as free trade with the EU – a positive for sterling.

b) Or, the market could be seeing a snap election as an admission from the government that executing its objectives on Brexit is harder than originally thought. This increases the likelihood of a ‘transition’ deal with the EU, or a second independence referendum – again, both a positive for sterling.   

Whatever the outcome, the trajectory for sterling looks uncertain, and the coming weeks and months may see opportunities to sell or take short positions in those companies that have benefitted from recent strength. It is also worth remembering, however, that approximately two-thirds of FTSE 100 company revenues originate from outside the UK. Any pull back in sterling may therefore be positive for selected UK-listed equities, given that their earnings are repatriated back into a weaker currency. It will therefore be important to invest selectively and maintain flexibility to adapt to shifting circumstances.

Having been taking profits from rising markets and establishing new short positions ahead of today’s announcement, this positioning seems timely. We are now looking to take additional tactical positions to seek to take advantage as markets react to today’s news.