Much like the FTSE 100’s downbeat performance so far this year, the deadline for the UK and EU to reach a deal over Brexit has been a slow-moving target. The closer we get to the cut-off point, the further the London blue-chip index drops. With trade negotiations ongoing and the UK’s final transition set for 31 December, how are investors positioning?
Before the coronavirus pandemic panicked investors, the FTSE 100 had been headed towards its 2019 high of 7,686.60p, which it reached on 29 July that year.
The London index opened 2020 at 7,542.40p, before it crashed 33.8% to a low of 4,993.90p on 23 March. Shares in the FTSE 100 had reached an intraday low of 4,898.80p on 16 March — its lowest price since 2016 — and it wasn’t until the end of that month that it began to recover.
By the end of April, the benchmark index had clawed its way back to the 6,000p mark. It continued to trade above this point between mid-May and mid-September. As the Brexit negotiation deadline that Boris Johnson had set in September — 15 October — approached, the FTSE 100 was largely flat. Shares fell 0.5% over the first 15 days of October to 5,832.50p.
However, the deadline came and went without any resolution and the FTSE 100 is down 21.7% year-to-date at 5,786.80p as of 5 November.
YTD price fall of the FTSE 100 as of 5 November
Deal or no-deal
Negotiations have since continued, moving from London at the end of October to Brussels at the start of November. The talks are set to last until mid-November, according to Bloomberg.
Since the referendum vote in June 2016, the FTSE 100 has lagged behind almost all other major stock indices, including the S&P 500, the DAX and the CSI 300. The main reason for this underperformance is the index’s weighting towards struggling sectors, including financials and energy.
Despite the FTSE 100’s inverse relationship with sterling, its underperformance throughout the year so far hasn’t lifted the pound. The pound is down 1.1% year-to-date against the dollar at $1.29 as of 5 November.
However, in the run-up to the Brexit deadline, sterling had been performing better. While the FTSE 100 fell 4.9% in October, the pound was up 0.4% against the dollar. Meanwhile, the FTSE 250 was relatively flat throughout the month, declining by 0.6% as domestic British businesses weighed in on a no-deal Brexit.
Price fall of the FTSE 100 in October
In the year-to-date, the domestically focused mid-cap index has outperformed its blue-chip peer and is down 18% as of 5 November. In comparison, the Stoxx Europe 600 is down 11.8% in the same period.
Karen Ward, chief market strategist for EMEA at JPMorgan Asset Management, expects the FTSE 250 to underperform the FTSE 100 in the event of a no-deal outcome, according to the Financial Times. She believes the blue-chip index would rise in absolute terms, while sterling would decline by as much as 10%.
In a scenario where a deal is reached, Ward forecasts sterling will appreciate by circa 5% because it would ultimately remove the risk of any economic shock of a no-deal.
"If negotiations do not look like they are proceeding to a fruitful conclusion, UK investors should seek alternative options to hedge the value of their portfolio. By contrast, if our base case looks correct and a deal can be agreed — that might actually be the time to buy UK stocks,” Ward said.
“If negotiations do not look like they are proceeding to a fruitful conclusion, UK investors should seek alternative options to hedge the value of their portfolio. By contrast, if our base case looks correct and a deal can be agreed — that might actually be the time to buy UK stocks” - Karen Ward
How investors are positioning ahead of Brexit
As the long, drawn-out negotiations to seal a trade deal between the UK and EU continue to weigh down UK stocks, investors might be tempted to close losing trades, but Barclays analysts advise against that.
The UK investment bank suggests focusing on the long-term to ensure that investors don’t have a “knee-jerk reaction when markets are choppy”. It also notes that a weaker pound would be beneficial to UK multinationals, as it would result in a weaker exchange rate.
Despite UK government borrowing hitting its highest level on record of £246bn in the first half of the year, advisors do not believe the outcome of the ongoing Brexit negotiations to be a major consideration for investors, according to an FTAdviser poll.
Data indicated that, while 37% said they’re likely to increase exposure to the UK equities in the year ahead, 33% don’t expect to. Meanwhile, 29% said their exposure was dependent on the result of negotiations.
For Rupert Thompson, chief investment officer at Kingswood, the differences between the two options now on the table — a no-deal or a very minimalist no-deal — are already factored into the markets.
As a result, he doesn’t expect the pound to fall much in the event of a no-deal. “As regards the continuing underperformance of UK equities, this probably reflects the view that Brexit, whatever form it ends up taking, is the last thing the economic recovery needs right now,” Thompson said.
“If there is no-deal, the impact may be more visible in intra-market moves rather than on the market overall. A fall in the pound would provide some protection to the FTSE 100 as around 75% of its revenues come from abroad” - Rupert Thompson, chief investment officer at Kingswood
“If there is no-deal, the impact may be more visible in intra-market moves rather than on the market overall. A fall in the pound would provide some protection to the FTSE 100 as around 75% of its revenues come from abroad,” Thompson added.
The UK stock market is battling a perfect storm of headwinds. A second national lockdown has sent shares across the leisure, banking and building sectors crashing, while ongoing political and economical uncertainty over a trade deal has created turmoil. With so many factors at play, it would be wise for investors to tread carefully when looking for the best opportunities.