It's complicated: New pound-FTSE relationship is a bad omen

LONDON: Brexit negotiations are as unpredictable as they are volatile, but one constant in the two years since the referendum has been the inverse relationship between sterling and UK stocks. Not anymore.

This month, the 40-day correlation between the pound and FTSE 100 turned positive, rising to the highest level since the aftermath of the 2016 referendum on Monday. The benchmark has lost about 2% in August while the pound has fallen by a similar magnitude.

Ever since the Brexit vote, the prevailing logic has been that a weaker pound boosts the overseas earnings of globally exposed UK stocks.

That’s why, counter-intuitively, bad Brexit news can sometimes give large-cap equities a boost. But that relationship is changing because the stock market and the currency are each being pressured by something more foreboding: global risk aversion.

“When you get this positive correlation, it tends to be symptomatic of more generalised market stress,” said Ian Harnett, chief investment strategist at Absolute Strategy Research Ltd in London.

“While there will be some translation effect boosting earnings per share from the decline in the exchange rate, if the strength of the dollar comes from worries about global growth, the transactions effect will dominate.”

The last time the correlation turned positive was in early March, briefly, after the pound dropped with the FTSE 100 amid a global market meltdown.

Current trends notwithstanding, Harnett sees longer-term correla- tions remaining negative and advises investors to closely monitor the relationship for signs of a reversal.

Movements in the dollar have dominated global currency markets of late, surging earlier this month as concerns about a slowdown in emerging markets fuelled a flight to quality before dipping in recent days as those fears subsided and US President Donald Trump railed against monetary tightening by the Federal Reserve.

The FTSE 100 was down 0.1% yesterday even as sterling weakened 0.2%.

The eurozone is seeing a similar breakdown in the relationship between the common currency and equity markets. — Bloomberg world’s biggest economy heads for its best growth since 2005, buoyed by robust domestic demand and the impact of tax cuts.

The Federal Reserve remains on track for further interest-rate hikes this year, despite a meltdown in emerging markets, rising geopolitical risks and mounting political headaches for the Trump administration.

Investors don’t have much flexibility in their investment decisions in the current environment of low interest rates, unattractive credit spreads, high equity valuations and flat yield curves, Seidner said.

One bright spot is private credit in areas such as direct lending, stressed and distressed corporate loans, as well as real-estate focused offerings including non-qualified US mortgages and commercial development loans in the US and Europe, according to Seidner.

“The opportunity set in private markets continues to expand and that we believe it to be a very significant, profitable and fruitful area for investors,” he said. “Instead of earning 5% or 6%, one can earn 10%, 11%, 12%.”

Seidner, who helps run Pimco’s Dynamic Bond Fund and sits on Pimco’s investment committee, left the company briefly in 2014 before rejoining later that same year. He also worked with Mohamed El-Erian at Harvard University’s endowment. — Bloomberg