Brexit – the outlook for the FTSE 100

As the referendum nears, we have seen increased volatility for most asset classes, with £100 billion wiped off the value of the UK’s top 100 shares. But what is the outlook for the index beyond the vote?

City of London skyline
Source: Bloomberg

With so much riding on the Brexit referendum, it has not been surprising to see the FTSE 100 fall back below 6000, surrendering much of the ground gained since the February low around 5500. However, it is arguably the case the index could offer good upside over the longer-term regardless of the outcome of the UK’s vote.

In the short-term, a vote for Brexit would most likely result in a swift decline for the index, perhaps down towards 5500 in the first instance. We have seen the index drop back in recent days as polls start to give a lead to the ‘Leave’ camp, and investors pull money from UK equities. However, in the months following, the expected weakness of sterling would help to boost earnings for firms in London that report earnings in that currency. It would also make UK exports cheaper overseas, boosting revenues for those firms with significant business in other countries.

A heavy weight to defensive stocks such as utilities for the UK makes it attractive on the idea that bond yields will remain depressed, so a yield play points to a preference for the FTSE over Europe. In addition, the 30% exposure to emerging markets for the UK boosts the outlook for the index given the bank’s expectation that emerging markets will perform better than their developed peers.

This latter point is based on the idea that the USD will continue to weaken, as the Fed tiptoes further away from rate hikes this year. Emerging markets look to be cheaper as well, with the MSCI emerging market index on 12 times earnings versus 17 times for the US.

Improved commodity prices, which should be the usual follow-through from US dollar weakness, also supports the idea the FTSE 100 is well-placed at present despite Brexit risks. Both the oil and mining sectors look, quite honestly, ridiculously cheap on PB metrics (JPM says record cheapness over 40 years), with demand/supply imbalances shifting back in favour of the former.

If the UK votes to stay, then a strengthened pound is a likelihood, which would then weigh on corporate earnings. However, with the fear of Brexit removed, it is arguably the case that global stock markets may start to rally, with the FTSE carried along in the tide. In this case a move back above 6300 could develop, which might then allow investors to contemplate a world in which the index continues on to test the area around 7000 over the longer-term. 

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