Marius Paun | London, UK | Senior dealer | Wednesday, 18th December 2019
Finally, we had the general elections here in the UK. The Conservative party won it with a landslide, giving Prime Minister Boris Johnson a very comfortable majority of 80 seats in the House of Commons. What was surprising was not necessary the victory, which was predicted by the polls, but the extent of it, with the Labour party suffering the worst defeat for more than 30 years. So it is safe to say that some of the political uncertainty regarding Brexit has been considerably reduced. The UK Government’s slim majority which in turn fuelled an ongoing internal division has now dissipated.
However, even with the domestic disruption out of the picture, things are not at all settled. The current deadline for leaving the EU is 31stof January 2020 and that seems to be the last one. At the same time, Boris Johnson promised to strike a trading deal with the EU by the end of 2020. This has prompted Brussels leaders to start to moan….’ it will be difficult’ or ‘there won’t be enough time’. And the main reason mentioned in the press is that between the time of leaving the EU and reaching a trade deal, the UK will still be bound by the single market rules. For now, at least, the deal Johnson negotiated before the election is the status quo. Can we expect some extra pressure from the British side for a speedier process? Let’s wait and see.
In addition, the UK voters sent a clear message that they are not keen for higher taxes, a massive increase in spending, a return to the nationalisation of several industries or outright hostility towards entrepreneurial spirit. Markets reacted immediately and the feel-good factor sparked a sharp rally in the pound sterling (although it retraced to a level seen before the election in less than a week). But what about shares? The financial press is filled with hints that this a good time to think about having some exposure to UK stocks.
Recently, the UK market was trading on an average price to earnings ratio (widely used as an indicator for valuation) of below 13 times, which is well below its long-term average of around 16. Regarding Brexit, Capital Economics is pointing out that before the 2016 referendum, the US and the UK had a price to earnings ratios very close to each other. But since then there was a very fast decoupling, which led to the UK has a 25% lower valuation currently compared to the US. Interestingly enough, Barclays Bank said that global funds managers have reduced their share of UK assets since the referendum on a consistent basis. UK assets outflows surpassed 10% in 2019. Nonetheless, Barclays added they’re seeing the tides turning with fund managers buying into Britain again.
Investing in FTSE 100 shares as a way to get exposure to the UK economy could be misleading though. Yes, the FTSE 100 is comprised of the largest hundred companies in the UK, by the market capitalisation, but these companies are predominantly big multinational corporations which have earnings in foreign currencies. In fact, over 50% of those earnings are coming from operations abroad, mainly in the USD, which then will be transferred back into GBP. So, stronger pound sterling will make those foreign earnings worthless, thus putting downward pressure on FTSE 100, despite the UK economy possibly starting to improve in performance. A case in point was the Brexit referendum in 2016 when sterling nosedived and yet the FTSE 100 rallied, despite the perceived negative impact.
By and large, the trend for the best part of the last three years has been sideways. Yes, it made an all-time high at 7902 on May 2018, but after that, an abrupt selloff followed. It is now at a level not far from the same time in 2016. As a side note, whilst all the US indices are making new record highs on a regular basis these days, FTSE 100 is still over 350 points off its record high. Whilst the fundamental narrative for a catch up with the US is strong, the technical picture is not so clear cut.
Recently, the FTSE 100 has shot up, even before the election, crossing above the strong resistance around 7430-7460 handle. The short-term trend is now up, and the next target is at 7600 marks followed by 7700-7720 area. If a breach of these potential resistance levels is successful, it will open the door for testing of the all-time high of 7902.
On the downside, the aforementioned resistance turned support at 7430-7460 comes first in line. Then, bears need to consider the 61.8 Fibonacci retracements (high of 7902 and low of 6500). Getting through here would clear the way to the next target, just below 7295, followed by 7200.