Photographer: Chris Ratcliffe/Bloomberg

JPMorgan Spots Split in U.K. Stocks With `Brexit' Debate

Updated on
  • Financial firms would be among the most hit in exit scenario
  • Rebound in miners and weaker pound help FTSE 100 this year

Britain’s potential withdrawal from the European Union is causing a rift in the region’s biggest stock market to widen.

QuickTake Will Britain Leave the EU?

While the FTSE 100 Index is one of Europe’s best-performing gauges in 2016, benefiting from the drop in the pound and a rebound in commodity stocks, firms that would be most hurt by an exit from the EU are getting left behind. An index compiled by JPMorgan Chase & Co. tracking 11 such companies, including Barclays Plc and Next Plc, is down 13 percent this year. It trails the FTSE 100 by the most since 2014, or about 11 percentage points.

Among investors betting the divergence will continue is James Illsley at JPMorgan Asset Management, one of the world’s largest money managers, who has allocated about 80 percent of his U.K. equity fund to FTSE 100 members. A “Brexit” would particularly hit financial companies, which account for more than half of JPMorgan’s EU Referendum index, because it could prompt the Bank of England to keep interest rates low for longer, potentially hurting lenders’ profits, the New York firm said in a note last month.

“Rather than broadly hurt sentiment for all U.K. stocks, the threat of ‘Brexit’ has unveiled significant disparities within the market,” said Illsley, the U.K. equity fund manager at JPMorgan Asset in London. His firm oversees about $1.7 trillion. “On the bright side, you have the weak sterling being overlaid with a pick up in enthusiasm for miners and oil majors. That’s been a great opportunity for us.”

Uncertainty over the outcome of the June 23 vote on the nation’s EU membership has dragged the pound to a seven-year low against the dollar. That’s good news for some: JPMorgan Asset’s Illsley estimates that about 70 percent of FTSE 100 profits come from abroad. Anglo American Plc and Glencore Plc, the battered stocks of 2015 that have rebounded more than 80 percent this year, are among commodity companies that report their earnings in dollars.

On the flip side, all but one of the members of JPMorgan’s EU Referendum index are down this year. Clothing retailer Next, which has suppliers in 39 countries, touched a one-year low in February. Homebuilder Berkeley Group Holdings Plc and real estate companies British Land Co. and Land Securities Group Plc have lost more than 11 percent. With all their revenues coming from the U.K., not only are they missing out on the benefits of a weaker pound but they’re also becoming more vulnerable to any blips in domestic economic growth -- forecast to slow in 2016 for a second year.

The FTSE 100 is outperforming the Euro Stoxx 50 Index for the first time in five years. It has fallen 1.9 percent in 2016, compared with a 8.8 percent plunge in the regional measure. Still, even U.K. financial companies have suffered in this year’s rout. With losses of more than 21 percent, Royal Bank of Scotland Group Plc and Barclays are the biggest decliners in JPMorgan’s EU Referendum index.

While sentiment for U.K. stocks has generally improved with this year’s performance, the country remains the least-favored in Europe for fund managers, according to a Bank of America Corp. survey last month. About 54 percent of the nation’s stocks are owned by investors based outside of Britain, leaving them vulnerable were it to leave the EU.

But for the time being, concerns have remained subdued. A gauge of FTSE 100 volatility expectations for the next 30 days is at its lowest level of the year relative to another index tracking euro-area stock swings. Traders are instead focusing on hedging against losses further down the road, with bearish six-month options on the U.K. benchmark measure near their most expensive prices since June 2012 relative to bullish contracts, data compiled by Bloomberg show.

“‘Brexit’ headlines between now and June have the potential to create toxic vapors that are unlikely to be helpful to U.K. financial markets,” said Michael Stanes, investment director at Heartwood Investment Management in London. He helps manage 2.4 billion pounds ($3.4 billion) and is underweight British shares. He prefers the bigger, more international stocks on the FTSE 100. “Large-cap U.K. equities should weather the storm better than small- and mid-caps.”

(Updates with Tuesday trading from second paragraph.)
    Before it's here, it's on the Bloomberg Terminal. LEARN MORE