British stocks and shifting political sands

FTSE 100 fillip

Whilst the election result is a shock result for any asset class, it's evident that the overnight discount on the pound has proved to be too tempting for investors in British companies that export goods or services overseas. This has given the top-tier index a shot in the arm this morning.

The outcome does not look like a clear-cut fillip for the blue-chip market overall though. After all, the largest FTSE groups would face months of negative sentiment should the official opposition get anywhere near power, due to their plans to tighten the corporate tax regime. Whilst a remote possibility, investors are likelier to countenance even the remotest negative case this morning after being delivered of another largely unforeseen voting result in less than a year—even if it’s one that could in the end bring about the softer Brexit that most investors seek.

Mid-cap malaise

Still, as we’ve seen across both major votes Britain has endured since last June, domestically focused shares are those for which a surprise result is least welcome, and this is being played out again this morning. The roughly 50% of large groups that generate most of their revenues in sterling is a negative exposure for the FTSE 250 index. That is why the confirmation of a sterling-negative outcome is pressuring the mid-cap market as I write. As we stated earlier in the week, we see scope for the index to slide in the second half of the year as sentiment on its many Britain-dependent businesses weakens. One sign of that deterioration is that since the Brexit vote the usual pattern of their trailing price/earnings ratios—the FTSE 250’s tending to be higher—has gone out of kilter. This has only happened once in a sustained way over the last 20 years or so. After the FTSE 250 largely matched the performance of the FTSE 100 over a year and even outpaced the blue-chip market since January, it can therefore be expected to diverge downwards from its higher-capitalised cousin.

Home and office

Even on the blue-chip list, the losers are shares with tighter ties on Britain. Both Residential and commercial property groups were among the deepest fallers on Friday. Again the sector typically is in the first wave of selling under such circumstances like this morning’s. Even so, whilst investors often seem to be ready to take opportunities to trim soaring housebuilder shares—Persimmon, the biggest gained almost 40% up till late-May—notwithstanding cooling demand, recent experience suggests even a significant residential property stock sell-off will be short-lived.

The medium-term outlook for developers of office space and commercial premises however, does seem to have been dealt a further blow by a hung parliament result. The inconclusive political and economic state that by implication will prevail at the start of Brexit negotiations will concentrate minds of potential leasing clients in the capital and beyond. Contingency plans aimed at maintaining a commercial or regulatory footprint in the EU could be triggered now, and that will reduce demand for office space. The largest office developers also signalled in their recent annual results a deceleration in the pace of building as a high point in the cycle for both land prices and office space dents development economics, and as rents drift off the highest prices since the financial crises.

Once again, even within the commercial development sector, we find that investors are most turned off by the most domestically exposed. Shares of Intu Properties, responsible for developing and operating a large chunk of Britain’s leisure and retail estate, appeared to anticipate the election result this week, slipping whilst rivals were steady. It was the worst-off REIT at the time of writing.

Large retailers were also amongst the now customary anchors of the top-tier market this morning and more widely, the market is also revealing continuing wariness on consumer-dependent groups with existing vulnerabilities, or which have already had a rough start on the road to Brexit journey—e.g. EasyJet, Next, Sky and ITV.

A more selective bounce

Equity investors might well expect Britain’s stock market to mirror its recent routine of quickly finding its feet after a market shock. However the one delivered by the Conservatives drubbing at the polls is likely to play out differently, not least because it has not been perceived to be as much as an outright negative in the first instance as was the case on the morning after last June’s Brexit vote. Whilst none of London’s shares can expect to remain entirely untouched by the latest sign of a much less certain political and economic landscape, we expect investor selectiveness to be clearest among the sterling-sensitive sectors we mentioned. At least until the pound has positioned itself—again—for the evolving and less-forgiving realities of a Britain outside of the Europe Union.