U.K. stocks lack backstop as Brexit deadline approaches
Many investors are staying away from Britain, worried that risks are too hard to price
U.K. stocks have become some of the most shunned assets in the world. One big reason: Investors have lost faith that a weaker pound will lift shares if Brexit takes a turn for the worse.
Investors have withdrawn money from U.K. equity funds for 10 consecutive months, according to fund tracker EPFR Global, while global fund managers have ranked the U.K. as their least favorite region in which to invest, according to Bank of America Merrill Lynch’s January survey.
That comes with the U.K. slated to leave the European Union on March 29. Some fear the U.K. could leave without a deal on the terms of the separation, causing disruption in trade, travel and financial markets. Stocks and the currency could suffer.
“If you get a scenario of ‘nodeal,’ clearly [the FTSE] will underperform; if you get a deal, sterling strengthens and that hinders the FTSE 100,” said Christopher Mahon, director of asset allocation research at Barings. “All this points to the same conclusion: Why touch the FTSE 100 before Brexit day?”
One thing that has changed recently is the relationship between the pound and stocks. After the Brexit vote, falls in sterling pushed the benchmark FTSE 100 stock index higher when economic, trade or political uncertainty in the U.K. rose. That is because roughly 66% of revenues for companies listed in the index come from outside the country, according to Fact- Set, so revenues that multinational companies earned overseas in dollars, euros or yen, were translated back into a weaker pound.
But the relationship between the FTSE and the pound has had much less influence over the index’s performance recently as investors fear a nodeal Brexit would cause not just a weaker pound but also disruptions to corporate operations. If investors don’t reflexively buy the FTSE when the pound falls, that could leave it vulnerable in the event of an abrupt exit from the EU or dramatic change in political leadership. That can be seen in the diminishing correlation be- tween daily movements of the pound and FTSE.
Another risk is that the Brexit political mayhem results in a general election that ushers Labour Party leader Jeremy Corbyn into office. He has pledged to break up banks, freeze energy prices, raise corporate taxes and renationalize public utilities.
“My biggest fear in the U.K. from an economic perspective is a Labour government,” said Christopher Peel, chief investment officer at U.K.-based Tavistock Investments, who is concerned about the possibility of long-term capital flight if U.K. corporate taxes move sharply higher.
Instead of buying U.K. assets, “I’d rather take that risk and play it in emerging markets, where at least you’ve got greater political stability,” said Mr. Peel, who favors stocks in places such as Brazil, Mexico, Peru and Chile.
On the flip side, if there is a market-friendly Brexit agreement, a significantly stronger pound might outweigh some of the benefits for companies listed in the index, investors say. So much bad news is currently priced into the currency, that the rebound could be particularly sharp.
To be sure, the potential for a steep move higher in the currency could simultaneously make the FTSE 100 appealing to a dollar or euro-based investor, even if the performance gains in the index are more modest. The FTSE 100 index also sits near its cheapest relative to U.S. and broader European stocks since 2010 in price/ earnings terms, and its dividends are around multdecade highs, offering potentially attractive returns.
But for many, the risks are too hard to price, deterring them from U.K. stocks, figuring they will continue to lag behind other markets.
“It’s too soon to call an end,” said Kevin Gardiner, global investment strategist at Rothschild Wealth Management.