Inside the Growing Bull Case on Megacaps in London Stocksby
British stocks are trading at record premium to European peers
FTSE 100 dividend yield is higher than Germany, France, Italy
Following Britain’s unexpected vote to leave the European Union, strategists did something that might seem strange: they turned more bullish on a big swath of the country’s shares.
The FTSE 100 Index, which tracks the largest companies trading in London, has been relatively resilient since the referendum, falling less than half as much as the broader FTSE 250 Index and a gauge of euro-area shares. It’s highlighting the disparity between the rest of the U.K. stock market and London’s large-cap multinationals, a group that benefits from its commodity holdings and business in emerging markets.
Since the vote to abandon the EU, HSBC Holdings Plc and Citigroup Inc. have raised their ratings on Britain’s biggest stocks, while JPMorgan Chase & Co. and Societe Generale SA said they’re still bullish.
The key is the currency, which plunged to a 30-year low. Strategists say the FTSE 100 is replete with multinational companies that can capture the sales benefits of a weaker pound, allowing them to weather any impact on domestic growth and trade with Europe. The FTSE 100 is still the region’s best-performing benchmark in June and trades at the biggest-ever premium versus the Euro Stoxx 50 Index, data going back to 2005 show.
“It’s not easy in the immediate aftermath of the vote to tell clients that staying bullish on the FTSE 100 makes sense,” said Charles de Boissezon, co-head of European equity strategy at Societe Generale, which boosted its recommended allocation to U.K. stocks at the beginning of June. “But Brexit hasn’t changed the fact that sterling will stay weak, commodities are rebounding, and you have a lot of good companies that provide growth and visibility. If you can clear out the fog, that story is still there.”
JPMorgan estimates that 30 percent of FTSE 100 sales are generated in emerging markets, while only about 28 percent come from the U.K. British American Tobacco Plc, which in 2015 relied on western Europe for less than a quarter of total revenue, has rallied 8.2 percent in the past six days to an all-time high. Shares of household-goods giants Reckitt Benckiser Group Plc and Unilever are also at or near records. Diageo Plc, which sells only 24 percent of its alcohol in Europe, has gained 4.4 percent since the U.K. referendum.
“The FTSE 100 benefits from large emerging-market exposure, it is a defensive high-yielding market, and the weakening pound is helping its overseas sales,” JPMorgan equity strategists led by Mislav Matejka wrote in a June 27 note. “The U.K. will remain a relative outperformer.”
The benchmark index climbed 2.6 percent on Tuesday.
Vastly different is the picture for the FTSE 250, which has plunged 14 percent since the referendum, a rout comparable to those in battered markets such as Spain and Italy. Companies on the midcap index make about half of their sales in the U.K., according to UBS Group AG calculations.
At 4.7 percent, the FTSE 100’s dividend yield is higher than that for benchmarks in Germany, France and Italy. A shift in sentiment would be an unexpected boon for a market that has long been out of favor with global fund managers. They’ve been underweight U.K. stocks for most of the past nine years, and it remains their most disliked part of the world, Bank of America Corp. surveys showed. Investors yanked money from U.K. equity funds in nine of the 10 weeks that preceded last week’s vote, according to a report from the bank citing EPFR Global data.
The FTSE 100 fared better than Europe before the EU was officially formed in 1993, rising 89 percent versus 51 percent for the Euro Stoxx 50 in about seven years. However, the opposite was true during the U.K’s membership years: the U.K. index was up 100 percent through June 23, lagging the 123 percent rally for the euro area benchmark. In 2016, the FTSE 100 has outpaced the Euro Stoxx 50 by about 13 percentage points after four consecutive years of trailing behind.
Still, some brokerages remain cautious. Credit Suisse Group AG has kept its neutral rating on the FTSE 100, cutting its year-end target for the index to 6,200 from 6,600 late Friday -- a drop of 0.7 percent from its level at the end of 2015. The index is expensive relative to earnings and uncertainty around Brexit will weigh on sentiment for U.K. assets, analysts led by Andrew Garthwaite wrote in the June 24 note. The FTSE 100 trades at about 14.8 times projected profit, above its three-year average, data compiled by Bloomberg showed.
But with fund managers around the world sitting on the biggest cash piles since 2001, Heartwood Investment Management is among those now eyeing the FTSE 100.
“We have entered this period with higher levels of cash,” said Noland Carter, who helps oversee about 2.5 billion pounds ($3.3 billion) as Heartwood’s chief investment officer in London. The firm will “re-orientate our existing U.K. exposure into large-caps. These are multinational companies with significant international earnings and should benefit from a weaker sterling.”