- Small, mid caps more likely to suffer from domestic slowdown
- Bank of England puts EU exit top of list of potential threats
Even as the U.K. stock market’s resurgence this year has made it among the most expensive in Europe, its smaller members are trading at multi-year lows. One reason? Concern over U.K secession.
With only six weeks to go before Britain votes on whether to remain in the European Union, the FTSE 250 Index of mid-sized companies is trading at its lowest level since 2010 relative to the FTSE 100 Index, with members of the FTSE SmallCap Index valued near a four-year low versus the large-cap gauge.
While some polls indicate the June 23 referendum is too close to call, the Bank of England has put the risk of a Brexit at the top of its list of near-term threats to the domestic economy. The National Institute of Economic and Social Research has also warned of a potential tumble in sterling that would damage growth prospects. If voters choose to leave, smaller companies that do the bulk of their business in the U.K. could suffer most from a weaker economy, according to Smith & Williamson Investment Management’s Mark Boucher.
“Small and mid caps have a much larger exposure to the U.K. earnings stream than the large caps stocks which are more international,” said Boucher, a London based fund manager at the firm, which overseas about 16 billion pounds ($23 billion). “So, if there is any risk of Brexit, it will be reflected more in these stocks.”
The FTSE 100 has fallen just 2.3 percent this year compared with the Stoxx Europe 600 Index’s 9.4 percent drop, as miners and energy producers surged on rising commodity prices, and the pound weakened. The FTSE 250 is down 4.6 percent and the FTSE SmallCap Index has fallen 1.3 percent.
Even after a rebound in the past month, the pound is still the worst performer in 2016 among Group-of-10 nations, weighed down by poor economic data and concern that leaving the EU will damp investment.
Among companies that could lose out from domestic weakness is Hill & Smith Holdings Plc, the heaviest weighted member of the FTSE SmallCap Index, which generates 50 percent of its revenue in the U.K. On the FTSE 250, paper company DS Smith Plc and Rightmove Plc also count the U.K. as their single-biggest market.
Prime Minister David Cameron and Chancellor of the Exchequer George Osborne have warned that the U.K. would be worse off outside the EU. They face high-profile opponents, including former London mayor Boris Johnson, who are campaigning for an exit from the world’s largest single market, underscoring a split in the ruling Conservative party. U.S. President Barack Obama is among international leaders to have urged the U.K. to stay in the bloc.
As the referendum approaches, a report yesterday added to the gloom gathering about the U.K.’s economy -- industrial production grew less in March than forecast as manufacturing barely rose and oil and gas output shrank. Data on construction and services industries last week also missed economists’ forecasts. The U.K. economy is forecast to grow 1.9 percent this year, which would be slowest pace since 2012.
“There is certainly a weakening of the U.K. economy which is partly a function of Brexit risk and will hurt smaller companies more than larger ones,” said Guy Foster, the head of research at Brewin Dolphin in London. “These cheap valuations in small and mid caps are likely to sustain in the run up to June 23 and beyond.”