Stock Markets After Brexit
Immediately before the Leave vote was successful in June 2016, there were claims of doom and gloom for the imminent future of the stock market should Brexit succeed from the protagonists of Project Fear. However, despite the pessimistic outlook of those who wanted the UK to remain within the EU, shortly after the result of the referendum was announced the financial markets began to rally in an unexpected Brexit Boom. In the referendum’s wake, the FTSE 100 once more entered bull territory, with its gains being extended to more than 5%, and the stock market again began to soar. In fact, since its low point in February 2016, the index was actually 20% higher in the period shortly after the referendum, flying in the face of those who had predicted that a Leave vote would prove to be a disaster for the UK’s economy. In the days leading up to the referendum, the Remain camp were keen to point out their negative forecast for the country’s finances should the Leave side win, declaring that it would be a disaster for equities, interest rates and the Pound Sterling in general. In fact, these predictions have now been shown to be incorrect.
Is the Equity Market a Reliable Gauge of the Economic Health of the UK?
While the equity markets are currently looking positive, it is unclear as yet whether or not they can be counted on as a reliable gauge of the economic health of the nation. While it appears to be the case that the FTSE 100 (the flagship equity index of the UK) has brushed off the result of the referendum, experts have warned that in fact this index may well be the one that is least representative of the sentiment regarding Brexit. Opinion is split in London as to whether the international finance centre of the capital is either at severe risk or whether it is sacrosanct and the companies which are listed in London are not all based within the UK, with the UK not necessarily accounting for a primary source of these companies’ revenues. The companies listed on the FTSE 100 index obtain the majority of their revenue from elsewhere in the world outside the British Isles and therefore these companies now have a higher worth in the Pound Sterling which has weakened since Brexit. Another factor is that many of the FTSE 100 mega-caps are defensive in nature, since the demand for the consumer staples that they sell is less sensitive than the demand for the products of the wider range of companies that are tracked in the UK’s other indices. For example, the UK’s more cyclical stocks comprise mining companies and these have rallied over recent weeks with commodities, but this is for various reasons and not necessarily because of Brexit. Experts therefore suggest that the FTSE 100 index should not be taken as a reliable indicator of the health of the economy, but instead suggest that we look towards the FTSE 250 instead, since the companies listed on it obtain just a third of their sales abroad. The FTSE 250 therefore shows a very different trend post-Brexit, having dropped over 3% since June 2016’s referendum.
Comparing the FTSE 100 and the FTSE 250
Both the FTSE 100 and the FTSE 250 have one thing in common and this is that the shares on each are denominated in the Pound Sterling and, if the value of the Pound drops, more weaker Pounds are necessary for purchasing a share in a company. When the value of the FTSE 250 is measured in US Dollars it shows a drop of 13% and, when accounting for exchange rates, the FTSE 100 also has a lower value than it had before Brexit. All of this means that, had you bought into a UK stocks tracking fund on the day before the referendum result was announced, your investment would now be worth less should you wish to change it into a foreign currency. This is true for virtually all forms of tender as the Pound Sterling’s 11% drop after Brexit is the steepest amongst all 31 of the major world currencies, with only the currency of Sierra Leone having lost more value. Therefore, the effect of the exchange rate is assisting the rally of the stock market together with the FTSE 100’s composition. The rally reflects the weaker discount rate which has been worked into the valuation models, and this decline in yields may confirm that the departure of the UK from the European Union will actually be negative for the country’s economic growth and therefore, in turn, wages and inflation. As around 75% of economists have reported that they believe the UK’s economy will once again slide into recession following Brexit, it follows that what appears to be positive for UK consumer stocks may not necessarily prove to be positive for consumers in the UK.