Two drivers of FTSE 100's post-Brexit recovery

The significant fall in sterling - and the potential for further weakness in the months ahead - has had a pronounced impact on UK equity market returns since June's Brexit vote. In particular, two clear drivers of performance have emerged.

This first is dollarisation. International companies with low or no exposure to the UK and a business in dollars have received an instant upgrade to forecast earnings per share and dividend.

The second driver has been index-linking. Regulated utilities have benefited on anticipation of increased inflation as they will receive a substantial tariff increase due to the terms of their regulatory contract.

Given my focus on large-cap stable dividend-payers, the portfolios I manage have benefited from some of the related moves in markets, particularly in areas like consumer staples and utilities. The funds' selective holdings in overseas stocks have also rallied on currency weakness.

Recession unlikely

However, the reverse side of this has been the significant underperformance of companies with exposure to the UK domestic economy, such as retailers, insurance companies and housing-related stocks.

Some domestically focused stocks are beginning to discount a significant further correction in sterling and a slump in the UK economy.

Although we will only begin to know how the economy has reacted to the referendum when the Bank of England produces its report in mid-August, I do not believe that a recession is imminent.

Ultimately, I expect investors to refocus and recognise the inherent value in these companies as these fears slowly subside.

In this regard, it is important to note that over the last 30 years recessions in the UK have been precipitated by interest rate rises to slow an overheating economy or, in the case of 2008, by a banking collapse.

There seems to be no risk of a repeat of the banking crisis of 2008 since there is plenty of liquidity.

Declines in business confidence are not enough to generate a recession without tangible negative events like interest rate rises, job losses and a credit crunch. None of these forces appears to be evident at present.

Instead, what has happened so far is a high-level political convulsion which I do not believe will affect the decisions of the bulk of the population.

A sterling recovery?

I am also unconvinced that we are in the midst of a long and pronounced period of sterling weakness and rising inflation.

The current dollar/sterling rate is $1.30, which is 8% below the average in 2015 of $1.53, and 10% below the average of the first half of 2016, which was $1.43.

If sterling does not recover, then it seems reasonable that inflation should rise from its present very low level of 0.5%.

Estimates of 4% or even over 5% in a year's time have been made by some economists, but again this is not certain to occur at all.

The trade weighted index is only just below its range established in the 2008 to 2010 period, before sterling took off in 2011.

Since the inflationary wave is not likely to be sustained, it may be that bank rate remains low even through the short period of higher inflation.

This all suggests a continuation of the current low growth, low interest rate environment for some time to come.

I believe this supports the outlook for high-quality companies that can provide shareholders with good prospects for increased dividend payouts across a range of conditions.

Michael Clark is portfolio manager of the Fidelity MoneyBuilder Dividend fund.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.