With the FTSE 100 reaching 7,120 yesterday, just undershooting its all-time high, this might seem like a strange time to ask whether investors should be ditching UK assets altogether.
However, as the blue-chip index surged, DeVere Group founder Nigel Green warned that Brexit-related risk means that such a “precautionary measure” is increasingly likely from UK investors between now and the end of March 2017, when Brexit negotiations are set to begin. Green didn’t mention equities in particular, but said that, mindful of the risks and ensuing uncertainty during talks, investors will rebalance away from the UK “in favour of global stocks, bonds and perhaps property too”.
So, as the UK prepares to leave the EU, is it time for investors to get out of the UK?
The FTSE 100 has been surging upwards since the Brexit vote thanks to higher commodity prices, loose monetary policy and, crucially, a fast declining pound. “It is a bit of a red herring,” says James Ind, manager of Barings Asset Management’s Dynamic Absolute Return fund.
Since Sunday, the pound has fallen to a 31-year low against the dollar, after the Prime Minister used her party conference speech to define a specific deadline for invoking Article 50, and to restate the government’s commitment to controlling immigration from other EU countries.
EU officials have warned that the free movement of people is a condition of access to the Single Market, and investors now fear a so-called hard Brexit, under which the UK may revert to trading with the EU under WTO rules and is likely to lose benefits such as passporting for financial services firms.
“The market is, probably correctly, seeing the exit as likely to be a firm one. And the market is probably correct in seeing that as a risk to growth in future years,” says Guy Foster of Brewin Dolphin. “That’s why the pound hasn’t rallied despite a positive run of economic surprises.”
But UK volatility isn’t such a problem for the majority of large-cap UK firms, which generate much of their revenues abroad. Just 25 per cent of large UK-listed company revenues are generated domestically, according to calculations by Geir Lode, head of global equities at Hermes Asset Management. Those in the materials and health care sectors rely on the UK for just 4 and 5 per cent of their respective earnings.
As the pound has slumped, the FTSE 100’s constituents have become cheaper for foreigners to buy. Thanks to this “export pricing competitiveness”, for them, the blue-chip index is a no-brainer.
When measured in pounds, the index is up 14 per cent year to date, notes Ind. However, while France’s CAC 40 is down 3 per cent in euro terms, it would be up 15 per cent if measured in sterling. Currently at $1.27, Citi analysts have said the pound could fall as far as $1.24, so the FTSE 100 rally is likely to continue.
Thanks to this “export pricing competitiveness”, the blue-chip index is a no-brainer for foreign investors
Perhaps most concerning is that the stocks which have rallied the most since February are confined to certain sectors, whose success has been sufficient to counter the drag from others. The highest risers – Anglo American, Glencore, Fresnillo and BHP Billiton – have bounced back from a very low base, thanks to a rally in commodities and the oil price following a torrid 2015.
Financial services and consumer discretionary shares, on the other hand, have foundered in expectation that Brexit will hit them hard.
Better than the rest
Other factors are supporting UK stock markets. Starved of income from the bond market, baby-boomers rich in savings and nearing retirement may continue to pour money into equity markets until central banks decide to raise interest rates, which would push up yields on government bonds.
Neither are the prices of UK shares particularly expensive relative to their company earnings, pointed out Laith Khalaf of Hargreaves Lansdown, unlike the last time the market peaked in 1999, “when the price-earnings ratio of the UK stock market stood at an eye-watering level.”
With the US Federal Reserve expected to hike interest rates soon, Capital Economics expects the dollar to strengthen through until the end of next year, which may attract further investment to the FTSE 100.
FTSE 250 companies also derive a significant proportion of their revenues from overseas, so the effect of a weaker sterling will also benefit some of them. It is probably also too early to say how a hard Brexit would crimp the economy, and dampen consumer spending.
The IMF’s latest global economic outlook offers a much more optimistic assessment of the British economy’s prospects this year than it did before the Brexit vote, which suggests the sharp sell-off in the FTSE 250 immediately after the referendum may have been short-sighted. The IMF may have trimmed its projections for 2017 even further since July, but the government is expected to announce public spending increases that could boost UK stocks.
The future of UK assets continues to divide opinion. Green is correct that the inherent uncertainties involved in extricating Britain from the EU make holding UK assets more risky. But Brexit is happening, and its implications are impossible to foresee. Investors will have to live with that.