An emergency response to Brexit
A rip-roaring day for the pound, which has climbed to its highest level since last year’s fun-filled, good-natured and scrupulously honest referendum.
The driver for the move looks to be signals from the Bank of England that it may soon raise interest rates.
The rally started yesterday in the wake of the BoE’s monthly policy meeting. While the decision was to leave everything as is, the policy summary added that “some withdrawal of monetary stimulus is likely to be appropriate over the coming months”.
This morning the pound got a further lift after Gertjan Vlieghe, a notably dovish member of the Monetary Policy Committee, gave a speech consistent with the “rates may rise soon” message.
Said Vlieghe: “…the evolution of the data is increasingly suggesting that we are approaching the moment when bank rate may need to rise.”
It’s all still words, of course.
And now the pound’s a bit stronger, the “evolution of the data” may itself change.
Specifically, if the pound remains at these levels it should – others things equal – put downward pressure of inflation and maybe lead the BoE to think a rate rise is less urgent.
Other things are never equal, of course. Especially for an economy that, given the current political trajectory, will soon experience upheaval on a grand scale.
Also worth noting is that the next rate hike will very likely just take us back to an official policy rate of 0.5%.
That’s the 5,000 year emergency low that persisted from 2009 until last August. Hardly Hawk Central.
The cut last August was an effort by the BoE to stave off the worst immediate effects of the referendum result.
But as you may have have read in these pages, it’s not the only “emergency lever” there is.
If our government ever extracts its collective head from its rear end, it may well have something else up its sleeve.
Specifically, it could opt to cut the rate of corporation tax to attract more companies to the UK (or bribe those thinking of leaving to stay put).
That in turn could boost the profitability UK companies – and open the door to higher dividend pay outs to shareholders.
It’s an argument my colleague Duncan makes here, dubbing the increased dividend pay outs Brexit could lead to as “Brexit Severance Cheques”
Of course, when it comes to investing for dividends, it’s the dividend yield that matters, not the absolute level of dividend per share.
In other words, a dividend of 10p per share is meaningless if you don’t know what the share price is.
If the shares are £1 each, that’s a 10% yield. If they’re £5 each, the yield is only 2%.
So if UK companies raise their dividend pay outs, don’t expect the share price to stand still.
One would expect the shares to rise until the yield is more-or-less where it was before (I’m simplifying grossly here to make the point).
That means there’s potential here for a nice capital gain as well as a good income yield.
Hypothetical scenario: you buy a share paying a dividend of 10p per share. You pay £2 per share, meaning you’re earning a dividend yield of 5%.
Then there’s a corporation tax cut, maybe in response to Brexit. Sterling weakens – this actually benefits the company in question because it makes most of its money overseas (a similar thing happened when sterling fell last year).
The company is making more money, in sterling terms, and paying less in tax.
So it doubles the dividend to 20p per share. The shares rally in response, but that’s just the icing on the cake.
The main benefit is that you’re now getting 20p for each share you own, having paid £2 for each share. That’s a yield of 10% – assuming you got in BEFORE the above began to play out…
Now, all of the above is hypothetical.
There’s a lot of ifs and buts here, a lot of moving parts.
But if, when Brexit happens, we get a similar currency response to the one we saw after last year’s referendum…
And if that also works to benefit some companies…
And there’s an emergency cut to corporation tax to soften the blow of Brexit/bribe businesses to stay…
Then it could mean a nice windfall – a “Brexit Severance Cheque” – for any investor who gets in before this starts to play out.
As I say, there are ifs and buts. But it’s a feasible scenario.
They key to it is getting positioned ahead of time.
If you wait until it’s a done deal, don’t complain if it’s already priced into the best dividend paying shares and the yields on offer are anaemic.
To see how you could take advantage of this unique situation, click here.