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Week in review: The best of times and the worst of times

Week in review: The best of times and the worst of times

This week gave us more discussions about moving forward with Brexit, which led to another fall in the value of sterling. While this is good news for the UK’s stock markets, it’s not so good for the size of its economy.

It was a week of contrasts. Sterling fell to its lowest level against the U.S. dollar since the mid-1980s, and to its lowest against the euro in five years. But it was also a week in which UK stock market indices roared ahead, breaching the psychologically important 7000 barrier. That the two are connected is obvious. Multinational companies with worldwide earnings bases make up a big proportion of the FTSE 100 Index. And for these companies, every dollar of revenue is worth more now than it was on June 23.

Still, it allows voters from both sides of the recent European Union (EU) referendum to say, “I told you so.” The Remain campaigners can point to the precipitous decline in the value of the UK currency as confirming their gloomiest predictions. According to newspaper reports, one result of sterling weakness is that the size of Britain’s economy has now dipped below that of France.

Meanwhile, the victorious Leave campaign can point to soaring equity indices as evidence that Britain is “open for business.” (That said, looked at in U.S. dollar terms, the FTSE 100 is actually down for the year.)

Sterling began to lose its value immediately after the UK electorate voted to leave the EU. This week’s further decline has been largely influenced by messages emanating from the annual conference of the ruling Conservative Party, where politicians took an increasingly hard line on migration and began to talk of a “hard Brexit” with no access to the European single market.

 

Bad side effects

Elsewhere at the conference, Prime Minister Theresa May appeared to signal that she would be more interventionist in monetary policies than her predecessors. She acknowledged that the emergency measures taken by the Bank of England since the financial crisis, including ultra-low interest rates and quantitative easing, had “provided the necessary emergency medicine after the financial crash.” However, she went on, these measures had caused some “bad side effects.”

 

Mixed bag

Global equity markets also produced disparate returns. In the U.S., the S&P 500 Index was marginally down amid uncertainty about the economy, courtesy of a report from the International Monetary Fund. By contrast, the FTSE Europe was up slightly. Despite ongoing concerns about Deutsche Bank, financial stocks rebounded as investors became increasingly hopeful that interest rates will not be cut further into negative territory. Japan produced one of the strongest performances. Like the UK, the country’s stock market benefited from a fall in the currency, with the weakening yen helping the Topix index to rise 2.1%.

 

Something of a liability

Tesco’s half-year results brought a welcome return to growth. It has been a difficult few years for Britain’s biggest retailer; the company faced an accounting scandal in 2014, after which it promptly suspended its dividend. It has suffered big dents in market share after a ferocious assault by German discount retailers Aldi and Lidl. However, figures for the first half of 2016 show a 38% increase in operating profit to £515 million (US$636 million), and like-for-like sales in Tesco’s core UK business rose 0.9% during the second quarter.

There is a downside, though. One of Prime Minister May’s aforementioned “bad side effects” has cast a shadow over Tesco’s results. Thanks to the rally in bonds, the investment return it uses to determine pension liabilities has fallen sharply. As a result, its pension deficit has ballooned from £3.2 billion (US$3.9 billion) to £5.9 billion (US$7.3 billion). Tesco has effectively dismissed this as a temporary accounting anomaly, seeing no need to increase pension contributions. But if central bank monetary stimuli and consequent rock-bottom yields endure into the longer term, many companies will be forced to pay much more into their pension plans.

 

And finally…

Ever got tired of explaining what it is you actually do? No? Well, spare a thought for an anonymous volcanologist from Honolulu who took to Reddit, the self-proclaimed “front page of the internet,” to discuss his geological grievances. The lava-loving scientist is so fed up with bad jokes about “vulcanologists” that he has had business cards printed with the words, “No, not like Star Trek. That’s a good one, though, I haven’t heard it before.”

Make no Bones about it, it’s an enterprising solution to an annoying problem. We hope that a step so boldly taken allows him to Klingon to some dignity.

 

Important Information

Foreign securities are more volatile, harder to price and less liquid than U.S. securities. They are subject to different accounting and regulatory standards, and political and economic risks. These risks are enhanced in emerging markets countries.

Companies mentioned in this article are for illustrative purposes only.

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