Well, they did it. British voters opted to leave the European Union and in the process, sent financial markets into a tailspin. But the biggest victim here would appear to be the British pound. The night of the Brexit, the pound was down 12% vs. the dollar, and while it has rebounded modestly, it’s still under pressure.
There are a lot of reasons to believe this is overdone. To start, let’s look at the numbers involved. The day in 1992 that Soros kicked the UK out of the European exchange-rate mechanism, the pound dropped about 4%. That was the infamous day when Soros “bankrupted the Bank of England” and the impact was roughly one third of what we saw the night of Brexit. That doesn’t quite make sense, particularly given that the pound already freely floated vis-a-vis the euro.
Furthermore, no one has an interest in the pound “blowing up”. While there is a lot of bad blood between the UK and the rest of Europe right now, no one wants to see the UK fall deeply into debt or a currency crisis. The UK and Europe will continue to be important trading partners and a strong UK, even out of the European Union, is good for Europe.
The United States still considers the UK and important diplomatic and military ally, and Japan desperately wants to slow the rise of the yen. (The same can be said of the U.S. and most countries these days.)
That Old 'Greenspan Put'
So if the pound sinks any further, I would expect major coordinated central bank action from Fed, the European Central Bank and the Bank of Japan to prop it up. Call it a modern day version of the old “Greenspan put”.
If you believe, as I do, that the pound will not be allowed to sink too far, it makes sense to go long the pound.
The easiest way to do that is to simply hold a portion of your cash balance in pounds. I’ve done that for a few clients. But if that’s not something your bank or brokerage firm offers, you can also get pound exposure via the Currency Shares British Pound Sterling Trust ETF (NYSE:FXB).
Short The Yen
Another, albeit indirect, way to play a normalizing of exchange rates would be to short the yen. No currency rose harder and faster after Brexit than the yen, which is something the export-dependent Japanese don’t want.
The yen should definitely ease when the fx market returns to “normal”. The yen has traditionally been the funding currency of the carry trade, and whenever the market goes into “risk-off” mode, traders unwind their leveraged positions, which means buying back yen; hence the recent strength. So a stable pound should mean a weaker yen.
Not The End Of The World
And finally, even most Brexit bears concede that Brexit isn’t necessarily the end of the world for Britain’s large multinationals, whose operations span the globe. (In fact, a weaker pound is actually better for the companies as it means their overseas earnings get translated at a higher exchange rate.)
So, even if British stocks trade sideways for several months, non-British investors would do well buying British stocks during a rally in the pound. A decent option here would be the iShares MSCI United Kingdom ETF (NYSE:EWU). Most of the companies here are old enough to have survived the collapse of the British Empire. If they can survive that, then surely they can survive Brexit.
Charles Lewis Sizemore, CFA is the principal of Sizemore Capital, an investments firm in Dallas, Texas.