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London stocks eye $1.30 sterling sweet spot

A firmer pound is shifting the ground for UK equities.

The direction of the pound has dominated share market performance since the UK voted to leave the EU last June. As the currency loiters around $1.30, shares of companies earning the bulk of their revenue in the pound have turned positive for the first the time since the Brexit referendum.

KPMG’s UK 50 index is specifically designed to track the market performance of companies that earn at least 70 per cent of their revenue in sterling. It has a sibling, the Non-UK 50, which follows only companies that make 70 per cent of their earnings abroad.

The twin benchmarks are designed to offer investors a clearer insight into how sterling’s fortunes sets the pace for UK stocks since last summer’s vote, after which the plight of the pound battered domestic stocks and gave foreign earners a significant boost.

While the non-UK 50 remains significantly ahead since the Brexit vote, with a gain of almost 30 per cent, the UK-50s move up above the flatline is worthy of note, since it comes at a time when investors are already re-assessing their strategies after the pound’s recent recovery to a seven-month high.

That high watermark arrives just as foreign revenue earners face potential turbulence from tougher year-on-year comparatives during the corporate reporting seasons due after the calendar flips round past June 23 this year.

“Clearly as we reach the anniversary of the referendum the mechanical upgrades from translating existing sales and profits will begin to slow,” points out James Illsley, manager of the JPMorgan’s UK Equity Core Fund.

That could encourage profit-taking, at a time when investors will also know the outcome of the UK general election, and so will once again face the prospect of flurries of volatility from the resumption of the Brexit negotiations.

Meanwhile, the pound’s recovery has turned attention back toward domestic revenue earners. Research from Barclays says UK banks, homebuilders and travel and leisure stocks all currently appear “cheaply priced”. It also remains upbeat on the prospects for the UK economy, upon which the fortunes of such sectors ultimately depends.

“With the UK unemployment rate now at multi-decade lows, inflation pressures peaking in Q3 2016 and survey data pointing to wage acceleration, consumer confidence should remain well supported hereon,” says Dennis Jose, Barclays analyst.

Could the $1.30 level, which the pound has either been heading towards or trading around since May, prove to be something of a sweet spot for UK stocks — enough to keep domestic revenue earners over KPMG’s flatline, while stopping short of unnerving multinational resource stocks and other overseas revenue earners?

JPMorgan’s Mr Illsley sounds upbeat, pointing out that on a trade-weighted basis, sterling remains almost 14 per cent weaker from the start of 2016.

“The UK’s export earners are therefore still benefiting from improved terms of trade which should continue to enhance their ability to gain market share and increase future sales in the medium term.”

Whether or not UK assets are about to offer investors a period of relative calm depends on a range of currently opaque factors, from the outcome of the general election to the nature of the Brexit talks and the subsequent terms of departure.

But at the very least, the attention that KPMG’s new model indices are receiving shows how the Brexit vote has left some of the more traditional tools relied upon by London investors more dated, and how demand for new ways to track the stock markets has grown since the Brexit shock.

Membership of the top-tier FTSE 100 — which was established in 1984 — and the mid-cap FTSE 250 — in existence since 1992 — is defined by market value, creating a greater degree of overlap in terms of domestic and overseas revenue exposure. The older index is home to major UK retailers such as Tesco and Sainsbury, alongside multinational oil majors BP and Shell, while its younger sibling has miners such as Kazakhmys sitting alongside high street bakery chain Greggs Both indices are up more than 20 per cent since last June.

There will be further squalls ahead for London’s stocks and the pound. Even while investor navigate calmer waters, those with the most up-to-date techniques for tracking market conditions will be better placed to cope.