By Christopher Vass, Peter Gunthorp, and Martin Howard
As we write, the Brexit trade deal is being rubber-stamped across Europe, and the FTSE 100 is up in post-Christmas trading. The UK remains by far the largest equity market in Europe investors even though FTSE 100 stocks have underperformed European equity markets by 40% the last five years.
If we examine the days after the Brexit vote, in local currencies the FTSE 100 did not sell-off more than the broader European equity markets. This is because this index has a higher percentage of ex-UK revenue. Conversely, the overseas activities by UK companies in the FTSE 250 index were said to be imperiled by the prospect of the UK leaving the European Union. So FTSE 100 vs. FTSE 250 has been seen as a tool to express views on the Brexit negotiations and future outcomes.
An alternative way would be to group companies by foreign and domestic sales instead of market-cap. Comparing the performance of the FTSE 350 Domestic Exposure Index (companies with high domestic sales) and the FTSE 350 Global Exposure Index (companies with high global sales) reveals a clear pattern— companies with high global sales fared better. The Global Exposure Index outperformed the Domestic Exposure Index with 17% the following two days after the vote.
Global exposure has continued to outperform the Domestic counterpart with 40% as of December 8, 2020. A closer look at the Industry exposures reveals that overweighting Healthcare, Consumer Staples, and Basic Materials has been the biggest reason for outperformance for the FTSE 350 Global Exposure Index compared to the FTSE Domestic Index.
But this is old news. What are the indexes telling us today? Of late, the Domestic Index has outperformed.
This suggests that the market has been pricing in a favorable deal for the UK. But companies with mainly domestic sales have a lot of catching up to do. With the performance spread, a wide valuation spread has also appeared. As the chart shows the discount of the Domestic Index vs. the Global Index fell ahead of the 2016 referendum, and has stayed stable between 30-40%. In late 2019 it started to narrow before Brexit, and stayed there until September this year, but today the discount is 30% again. One analysis of this is that Domestic has still a lower valuation than the Global and has room for multiple expansion to get back to historic valuation levels.
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