No Respite Seen for FTSE 100 Lagging Global Peers Most Since '03

  • Brexit concerns, sterling recovery pose risks for benchmark
  • Pound could be a ‘lose-lose’ for U.K. equities, says JPMorgan

U.K. mega-cap stocks are having a tough year, and their laggard days may not be over.

The FTSE 100 Index, the biggest loser among major European equity benchmarks in 2017, is trailing the MSCI All-Country World Index by the widest margin in 14 years. With fund-manager pessimism over Brexit showing no sign of letting up and sterling’s recovery threatening exporter profits, it’s likely the relative weakness will continue next year, strategists say.

The gauge has climbed 4.9 percent in 2017 and set its latest record in November. That advance trails the rally in euro-zone equities and the 20 percent gain in global stocks.

“The important point is that the FTSE 100 is not up as much as equities elsewhere, and its rally this year is simply a reflection of the good environment for equities in general,” Daniel Murray, head of research at EFG Asset Management in London, said by phone. “We have a cautious approach to U.K. equities and expect the uncertainty over Brexit to continue to weigh on that market next year.”

Even amid lingering uncertainties over the U.K.’s relationship with its largest trading partner and recurring turmoil in domestic politics, the pound is set to be the third-best performing Group-of-10 currency against the dollar this year, compared with an almost 17 percent decline in 2016. That’s bad news for the FTSE 100, whose members get about three-quarters of their sales abroad and tend to move inversely to sterling.

With the pound now topping analysts’ buy lists for 2018, strategists at JPMorgan Chase & Co. and UBS Group AG argue the boost from a weaker currency -- which propelled the benchmark to a 14 percent gain last year -- may have reached its limit. The banks are also warning that the old adage of a negative correlation between the asset classes could be getting stretched, so equities may suffer even if sterling retreats.

“GBP could be a ‘lose-lose’ proposition for U.K. equities, and the FTSE 100 versus GBP correlation could flip positive in case GBP gaps lower,” JPMorgan strategists wrote in a Friday note.

Another potential problem for the year ahead is the index’s reliance on commodities for earnings growth. About a quarter of FTSE 100 members belong to the energy and materials sectors, data compiled by Bloomberg show. While profits in those industries have benefited this year as commodity prices recovered from 2016 lows, UBS warns that this “base effect,” particularly for oil and iron ore prices, is set to fade going into the first quarter.

Analysts estimate FTSE 100 companies increased earnings by roughly 36 percent in 2017, but they predict the figure will drop to 6.7 percent for 2018, according to figures compiled by Bloomberg.

Many global fund managers have already capitulated on the region: a Bank of America Merrill Lynch survey last month found that pessimism toward U.K. assets has reached levels last seen during the 2008 financial crisis. EFG Asset Management’s Murray said his firm is positioning for a tougher stage of Brexit negotiations ahead, and sees the FTSE 100 continuing to underperform the rest of Europe next year.

“Despite the weakening macro backdrop and political uncertainty, the U.K. is trading in line with long-run average price-to-earnings multiples,” UBS strategists led by Nick Nelson wrote in their 2018 European equity outlook last month. “This is not a sufficient discount to make the market attractive yet.”

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