Weekly Market Outlook

Bloomberg Pound-Fueled FTSE 100 Rally No Cause for Joy to U.S. Traders

As prospects of Brexit firm up, a fresh weakening in the pound has pushed the FTSE 100 Index of U.K. megacaps above 7,000 for the first time in 16 months. Not that foreign investors, who own more than half the nation’s equities, are rejoicing.

While the equity benchmark has surged 13 percent this year in local currency, it has declined more than 2 percent in dollar terms, the biggest underperformance since the global financial crisis. Exporters rose as the pound tumbled to its weakest level since 1985 after Prime Minister Theresa May said she’ll start the process of withdrawing the U.K. from the European Union by March 2017, while three senior figures in her administration said financial-services companies will get no special favors in Brexit negotiations.

Local investors have seen the value of their holdings increase as companies including drugmaker AstraZeneca Plc and whiskey company Diageo Plc, which get most of their revenue outside the U.K., rallied after June’s secession vote sent the pound tumbling. Remove the currency halo, and the FTSE 100 is still below the level it was at before the decision. That’s bad news for overseas investors, if they haven’t hedged to account for the sterling effect. North America accounts for 46 percent of all foreign holdings, according to the latest government report published last September.

“On one hand, for U.K.-based investors it’s been quite the boon; on the other, if you are a U.S. investor, it’s been more of a mixed blessing,” said Ken Odeluga, a London-based market analyst at brokerage City Index. “If you have your British holdings in dollars, you are actually going to get far, far less than you would have if we didn’t have this strong weakness in the pound.”

U.K. shares have become Europe’s highlight this year as firms from JPMorgan Chase & Co. to HSBC Holdings Plc recommended buying the stocks, citing the weaker pound and increased stimulus from the Bank of England. While analysts raised their estimates for profit growth in the aftermath of the vote, and economic data have been better than expected, earnings for FTSE 100 companies are still projected to contract 3.2 percent this year.

Although the inverse link between the pound and the FTSE 100 had begun to break down at the start of September, the respite was brief. May’s pledge to invoke the formal trigger for two years of Brexit talks raised doubts about what form the exit will take and the kind of subsequent trade deal struck. That, coupled with speculation that Britain will favor immigration control over safeguarding access to the single market, prompted fresh declines in the pound on Monday. The FTSE 100 closed within 1.7 percent of a record reached in April 2015.

Foreign holdings of British equities have grown over time. They stood at 54 percent at the end of 2014, the latest year with data available from the Office for National Statistics, versus just 31 percent in 1998.

Investors owning the country’s shares in greenbacks have suffered more than local ones in the past three years, and the biggest U.S. exchange-traded fund tracking the shares has seen outflows almost every month in 2016. Since the day of the referendum, the FTSE 100 has gained 11 percent in local currency, versus a slide of more than 4 percent in dollar terms.

“Given the pound weakness right now, for U.S. investors, it’s really only a win if you are a new investor and you’re bullish,” Odeluga said. “If you already own FTSE 100 companies, you’ve seen your investments depreciate.”