A quicksand economy and financial assets

The precarious nature of global financial markets remains a source of concern to investors. Brexit fears may have abated to a degree, but they remain ever present in the shadows. If we examine the recent performance of the FTSE 100 index and the GBP/USD currency pair, it is evident that market volatility abounds. Over the ten trading days from July 4 to 15, the FTSE 100 index endured five days of losses and five days of gains. Overall, Britain’s premier index has improved markedly from approximately 6,000 on June 23 to its current level of 6,669.24.

The one-year change for the FTSE 100 index is -1.25%, which is a remarkable achievement given the battering that the UK financial markets, and its currency have taken. Over the past month, we have seen substantial improvements in the performance of the FTSE 100 index. Between June 20 and 27, the index appreciated by 1.95% or 117.60 points. Between June 27 and July 4, it appreciated by 7.15% or 439.14 points, and between July 4 and 11 it appreciated by 0.19% or 12.81 points overall. From July 11, the UK premier index has gained 1.19% or 78.60 points. The 52-week trading range for the FTSE 100 index is 5,499.51 on the low end (February 11) and 6,813.41 on the high end (July 20, 2015). That the FTSE 100 index is a sliver off the 52-week high is remarkable given current realities.

The performance of the FTSE 100 index and the sterling is one of the most interesting relationships on a macroeconomic level. When the GBP weakens relative to other currencies, the export potential of listed UK companies improves. This naturally bodes well for the FTSE 100. This is precisely the reason we have seen such a strong resurgence in Britain’s premier index since the June 23 Brexit referendum. However, in recent days we have seen the GBP/USD currency pair bouncing off its 31-year low towards its current trading level at around 1.32. This makes UKproduced goods more expensive on the global stage and has resulted in a slight retreat in the FTSE 100.

However, the volatility that we saw over the course of July was particularly negative for the FTSE 250. This index is currently trading at 16,727.27, down 0.36% or 60.77 points. Over the past five days it gained 2.38% as the GBP stabilised against the greenback. For the year-to-date, the FTSE 250 has shed 2.78%, not dissimilar to the FTSE 100. This index has a 52-week trading range of 14,967.90 on the low end and 17,781.40 on the high end. The difference between the FTSE 250 and the FTSE 100 is related to where the profits of these listed companies are generated. 75% of profits in the FTSE 100 are foreign-based, while the FTSE 250 is a British-based

index of listed companies.

Turning our attention to the GBP, there has been a strong resurgence in the trading range. Recall that the GBP/USD currency pair hit a 31-year low of 1.28 in early July brought upon by extreme market volatility vis-a-vis the Brexit. The GBP/USD currency pair – the cable – is one of the most heavily watched currencies of the summer. It has consistently been declining in 2016, having shed 9.37% for the year-to-date after opening at 1.4738 on January 1. The pair has made considerable gains in the past five days with an appreciation of 1.80%.

On July 11, the currency pair was trading at 1.2947, and it is now at 1.3184. This pair will remain extremely volatile in the coming weeks as Prime Minister Theresa May begins to spell out her plans, if any, for Britain and its extrication from the European Union.

There is no doubt that the Brexit debacle has thrown the UK economy for a loop. However, the economy was slowing even before the Brexit issue took centre stage. This was evident in the slowdown in growth, especially in manufacturing and construction. The services industry remains strong. When it comes to the Brexit-influence on the UK economy, we will not have much hard data until the end of July, August and September. Preliminary economic results will slowly become available and they will be revised to reflect new realities in the United Kingdom. Nonetheless, the Q1 2016 gross domestic product growth (quarter on quarter) is 0.4% with the economy having changed by 2.1% on an annualised basis.

During Q1 2016, the performance of the economy can best be described as subdued. We will know how it has performed for Q2 within the next two weeks. However, any Brexit-related impact will not be felt until much later in the year. The UK has been struggling to return to its pre-2008/9 recession level, and it only managed to do so by the end of 2015. In terms of Q3 predictions, GDP growth is largely expected to decline to 0.28% from 0.56% (quarter on quarter). This is largely due to trade data from May and purchasing managers index data for June. There is no doubt that the shock outcome of the Brexit referendum on June 23 will negatively impact the quarterly growth rate.

The IMF had anticipated the U.K. economy to grow at a robust rate in the presence of a ‘remain’ vote. However, that has been completely upended and now the IMF has reversed its position. In fact, IMF chief, Christine Lagarde expressed serious concerns about the performance of the UK now that it has voted to leave the European Union. We are seeing all manners of negative effects impacting the UK economy with demand for government bonds reaching multi-year highs and yields dropping to multi-year lows. The GBP/USD currency pair has plunged to a 31-year low, and is only now slowly starting to recover. The unemployment rate is 5%, with the employment rate at 74.2% and weekly earnings growth over the three months to April increasing by 2.3%.

Nonetheless, all of this static data will mean precious little now that financial markets have adopted a risk-on approach to the GBP and many multinational conglomerates are looking to shore up their investments by possibly relocating from the UK to the EU or elsewhere. We have seen markets see-sawing from a risk-off approach to equities to a risk-on approach to equities as the balance continually shifts. Strong jobs data in the US resulted in traders going all-in on Wall Street, and the FTSE 100 index has rallied on the back of a weak GBP.

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