It is a “coin toss” as to whether sterling will rally or fall by 15 per cent over the next two years, according to Royal London Asset Management’s Trevor Greetham (pictured), who warned that uncertainty surrounding Brexit negotiations could be the “biggest risk” on the cards for portfolios. 
The head of multi-asset also said UK equities have consistently underperformed relative to the broader market over the last decade due to the underperformance of UK earnings versus earnings globally.
While he is underweight UK equities across his GMAP portfolios, however, the manager is positive on the asset class and is overweight Japanese and emerging market equities.
“I think it’s quite credible to believe the pound goes down 10 or 15 per cent from here on a ‘no deal’, ‘crashing out the EU’ outcome. In other words, like the referendum all over again,” Greetham reasoned.
Performance of sterling vs US dollar 23/06/2016 to 23/07/2016
Source: FE Analytics
“It’s also quite credible for the pound to go up 10 to 15 per cent from here back to where it was before the referendum result if we had a soft, single-market type transition period. Who knows?
“I think it is a bit of a coin toss between the two, but there you have a 20 to 30 per cent range of where the pound is going to be in two years’ time.
“It’s the biggest risk and the biggest element of uncertainty in everyone’s portfolios.”
Following the plummet in sterling during the aftermath of the EU referendum, the global-facing FTSE 100 index rallied as exporters reaped the benefits. Gilt yields also dropped as investors piled into risk assets.
As “befuddling” Brexit negotiations continue, the head of multi-asset said sterling will either plummet further which will bruise the economy and the housing market but bolster the stock market, or the pound will strengthen which will benefit the economy and the housing market but deal a blow to equities.
As such, he believes holding direct UK property alongside any UK equity exposure should provide somewhat of a hedge against future currency fluctuations.
“In terms of the relative performance of the UK versus the market, the UK has been one of the most consistent performers. And by consistent performer, I mean consistent underperformer,” Greetham continued.
“This has been the case for more than 10 years. The red line [below] shows the earnings trend versus the rest of the world and that’s the prime reason for it.
“This relative underperformance of UK earnings is nothing to do with the UK economy as 70 to 80 per cent of FTSE 100 earnings are made overseas, this is because of the big mining stocks. Commodity prices have been dropping in the China slowdown and the UK has underperformed.
“I think the UK will continue to underperform and it will remain one of our underweights.”
Earnings and price trend of UK equities versus world
Source: RLAM, Thomson Reuters Datastream
Generally speaking, the manager believes Chinese growth will continue to disappoint over the medium term. While he said business confidence indicators in the country have picked up slightly, he reasoned that the country’s central bank could start tightening after its five-yearly National Congress of the Communist Party of China is held in November.
In order to hedge against the uncertain outlook for the Chinese economy, Greetham is holding overweights in both Japanese and emerging market (EM) equites.
“EM and Japan have something in common and that is they tend to do pretty well when global growth is strong,” he explained.
“Japan is a very interesting market at the moment because, if the dollar is strong and the yen is weak, Japanese equities go up quite a lot.
“It is possible you want to get Japan exposure with the currency hedged, so the fact the yen is weak doesn’t reduce your returns. That’s how we get exposure across the portfolios.
“Being overweight both Japan and EM is a bit of a hedge. If the dollar is strong, Japan does well, if the dollar is weak, EM does well.”
The head of multi-asset pointed out that both emerging markets and China tend to thrive when the dollar is weak due to high levels of debt denominated in the currency.
While both markets have performed well recently as the dollar has indeed weakened, he is unsure whether dollar weakness will continue over the medium term.
“It has weakened too much, we think, recently, mainly to do with shenanigans in the White House rather than fundamentals, and we think if the Fed comes back into play and hikes rate, that will happen in December,” Greetham continued.
In contrast, if the dollar strengthens, the manager believes Japanese equities could benefit as the yen will depreciate on a relative basis. Greetham said the Japanese stock market tends to thrive when its currency has fallen in value.
“Another interesting thing about Japan is that, if you’re worried that bond yields are too low and will rise in the UK and the US, you should buy some Japanese equities. They’re a great hedge,” Greetham said.
“If interest rates are rising in the UK and the US and bond yields are therefore rising in these markets, remember Japan has stapled its 10-year bond yield to the floor. They’re targeting zero per cent bond yields.
“As the differentials between overseas and Japanese yields widen, that weakens the currency. And the weak yen benefits the stock markets.”
The manager is positive on equities as an asset class because he doesn’t believe we are as late in the business cycle as many investors think.
While global unemployment rates are low, he said inflation across the board isn’t rising very much. He argued that many UK investors can lose sight of this, given rising inflation levels have been temporarily bolstered by the weakness of sterling.
“If you ask yourself why inflation isn’t really picking up despite the low unemployment rate, it is because there have been structural changes,” Greetham pointed out. “If you look at the US, the UK or Japan, you have part-time work or zero hour contracts. Although unemployment is low, people aren’t necessarily in a position to demand pay rises.
“Also, there is the ‘Uber-isation’ of jobs and the fact that service sector jobs can be outsourced to other countries very easily. It could also be the fact we haven’t had a lot of commodity inflation.
“Commodity prices rose a bit over the last year, but over the last four or five years they’re definitely down. As a result, we have a disinflationary backdrop. So, it’s a pretty benign environment still for equities.”