U.K. Blue Chips' Ride on Pound Seen Ending as Currency Rises

  • FTSE 100 had its worst drop in nine weeks as sterling rallied
  • BNP Paribas prefers European stocks to U.K. shares on pound

Jim Rogers Asks If Scotland Pushes Pound to $0.80

The pound is becoming a drag on the biggest U.K. stocks.

Its 1.6 percent gain versus the dollar in the week through Monday is undercutting interest in the FTSE 100 Index, which is packed with global companies whose earnings are crimped when sterling strengthens. The equities gauge declined 1.8 percent in the period, its biggest five-day drop since January.

Britain’s currency has largely traded in the opposite direction of its most international stocks since the Brexit vote last June, when the pound started a plunge that boosted megacaps from Glencore Plc to Burberry Group Plc and drove the FTSE 100 to a record close this month.

With Britain now hours away from making its legal declaration to leave the European Union, the pendulum is swinging back, with the two assets remaining inversely correlated.

“On the FTSE 100, we would see a stronger pound as a headwind, combined with headwinds such as a lower crude-oil price” for BP Plc and Royal Dutch Shell Plc, which make up almost 10 percent of the gauge, said Edmund Shing, the global head of equity and derivative strategy at BNP Paribas in London. “The pound is relatively cheap versus the euro and U.S. dollar at the moment, as we see a relatively hard Brexit scenario is currently priced into the currency.”

Rising expectations for a U.K. interest-rate hike next year amid faster inflation are buoying the currency after an 12 percent drop over the past year, even as the triggering of Article 50 of the EU’s Lisbon Treaty on Wednesday looms.

Turning bullish on the pound earlier this month, Morgan Stanley recommends selectively buying domestic stocks and selling pricier exporters, while BNP Paribas SA said investors should bet on European stocks instead.

For sterling bulls, the case centers on multiple factors, from the U.K. economy’s surprising resilience under Brexit’s shadow to doubts that the Donald Trump administration will deliver on economic pledges that have supported the dollar.

The bear case is that the continued uncertainty over the terms of Brexit may still weigh on the pound, and the prospect of U.K. monetary tightening remains far off. The pound is projected to end next quarter down at $1.21 and the year at $1.23, according to the median estimates in a Bloomberg survey of analysts, compared to about $1.259 on Tuesday.

In the case of a “rough Brexit,” in which the U.K. is unable to conclude new agreements and customs rules with its major trading partners in the two-year period of talks, a globally diversified multiasset portfolio could lose as much as 7.8 percent as the pound and European shares plunge, according to a blog post by MSCI Inc. earlier this month.

Under a “smooth” Brexit, such a portfolio could lose at most 1.6 percent, while a departure that benefits the U.K. could bring a gain of as much as 3.5 percent, MSCI said.

Ben Kumar, a money manager at Seven Investment Management, said his concern is that the pound may weaken so much that even U.K. megacaps suffer. Such fears have prompted him to boost exposure to other currencies, though he also has an option to hedge against the prospect of sterling rising to around $1.40.

“If the pound really does start to depreciate against all global currencies again on the back of most likely some sort of political referendum or Article 50-related fear, then the positive sentiment toward U.K. stocks goes away,” he said from London.

On a sector level, financial and real-estate firms are potentially the biggest winners, based on positive correlations with pound moves, Morgan Stanley analysts Lillian Huang and Graham Secker wrote in a note.

The pound “is already very cheap so we think a lot of the bad news is in its price,” said Secker, equity strategist at Morgan Stanley in London. “If the currency is going to start appreciating, chances are the U.K. equity market will start to underperform.”

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