Pound Magic Is Back as FTSE 100 Climbs Most in Europe After Vote

  • Companies in benchmark index get majority of sales from abroad
  • Stock volatility measure plunges as election risk passes

Pimco Is Not Expecting a Big Leg Down in Sterling

A slump in the pound after U.K. Prime Minister Theresa May’s election gamble backfired provided a boost to the nation’s equity benchmark, helping it rise the most among European peers.

The FTSE 100 Index of the largest British companies, which get more than two-thirds of their sales from abroad, rose 0.7 percent at 11:17 a.m. in London as sterling headed for its worst plunge since October. While 70 of its members rose, domestic firms such as homebuilder Taylor Wimpey Plc and Royal Bank of Scotland Group Plc slid at least 2.5 percent. The FTSE 250 Index of midcaps dropped 0.3 percent, and another gauge of smaller companies fell 0.5 percent.

“The overnight discount on the pound has proved to be too tempting for investors in British companies that export goods or services overseas,” said Ken Odeluga, a market analyst at City Index in London. “Domestically focused shares are those for which a surprise result is least welcome. We see scope for the index to slide in the second half of the year as sentiment on its many Britain-dependent businesses weakens.”

The U.K.’s government’s leadership has been thrown into doubt just 10 days before Brexit negotiations are due to start, as May not only failed to get the broad majority she had bet on when calling the snap election but also lost parliamentary seats held at the start of the campaign. While the political uncertainty was reflected in the pound, the currency weakness has been a boon for U.K. megacaps in the past year, with the FTSE 100 rallying 18 percent since the Brexit vote.

More on what the election result means for U.K. stocks:

While the gauges of British large, mid-sized and small-cap stocks had slipped from records hit in May, traders didn’t show much angst in the run-up to the vote, even as recent opinion polls indicated a narrowing lead for the Tories. Caution was reflected more in the options market, where investors increased hedging, pushing the number of FTSE 100 options outstanding to a 2017 peak and sending their cost to a two-year high relative to contracts for the Euro Stoxx 50 Index.

With the election risk past, the FTSE 100 Volatility Index tumbled 9.7 percent on Friday, compared with a 2.5 percent drop in the euro area’s VStoxx Index. History shows that the gauge of U.K. equity swings tends to reverse the moves from the run-up to a vote in the week following the event.

“Market worries will primarily be expressed in currencies,” said James Butterfill, head of research and investment strategy at ETF Securities, referring to the FTSE 100. “The Conservative gains in Scotland highlight an independence referendum now off the table, at least reducing uncertainty in one aspect.”

Stock investors and analysts will keep on monitoring the pound closely. In the aftermath of the Brexit referendum, strategists quickly raised their ratings on FTSE 100 companies, saying weakness in the currency would boost profits. Analysts now see a 35 percent increase in earnings for members of the gauge this year, compared with 11 percent for those in the Euro Stoxx 50. That’s pushed the valuation of the British gauge to 14.7 times estimated earnings, near the cheapest since 2014 relative to the European measure.

“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,” Odeluga said. “At least until the pound has positioned itself -- again -- for the evolving and less-forgiving realities of a Britain outside of the Europe Union.”

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