By: Mary Fjelstad, Senior Research Analyst
Last week, Britain triggered Article 50 of the Treaty of Lisbon, formally beginning the country’s exit from the European Union. As far as UK stock markets as measured by FTSE’s UK indexes are concerned, however, the process began some time ago as investors tried to foresee what this momentous event might mean for the UK economy.
The recent behavior of the FTSE 100 Index (large cap), FTSE 250 Index (mid cap) and FTSE Small Cap Index has been relatively volatile. On March 17, just four days after the British Parliament passed the Brexit bill paving the way for Article 50, they closed at record high levels. But on March 21 the indexes retreated off these high marks, in part because the EU stated that UK airlines will be restricted in routes and operations within EU countries. The FTSE 100 has by far the greatest weighting towards airlines among the three indexes, and over the 10 days to the end of March the airlines sector of the FTSE 100 index lost 4.8% of its value. As of the end of the first quarter, uncertainty continues to dominate the UK equity and currency markets.
Looking further back to last June, the FTSE 100, 250 and Small Cap indexes, all lost value immediately after the referendum decision to leave the EU.
The FTSE 100 recovered almost immediately, however, marking the start of a prolonged upward trajectory. The FTSE 250 and the FTSE Small Cap Index both suffered a greater decline in value than the FTSE 100 in June 2016, and interestingly enough, the FTSE 250 was hit hardest. Both indexes took a bit longer to recover than the FTSE 100, but by August 1, 2016 were back at pre-referendum levels. By February 2017, the FTSE Small Cap Index was close to parity again with the FTSE 100, but the FTSE 250 has yet to catch up.
So why has the FTSE 250 performed so differently from the other two UK indexes since the Brexit vote? Market observers have suggested that the FTSE 250 may be tied more closely to the domestic UK economy than the FTSE 100. Pessimism over the long term prospects for the domestic UK economy could therefore explain why it was hardest hit in June 2016, and has since struggled relative to the FTSE 100 and the Small Cap Indexes.
The FTSE 100 is comprised of the largest companies (by market capitalization) listed on the London Stock Exchange, which usually have a greater proportion of their revenues derived from international sources. Conversely, smaller companies tend to have more domestic market focus. It should therefore come as no surprise that the FTSE 100 was less affected than the FTSE 250 by the Brexit 2016 vote and shook off its impact almost immediately. The decline in March 2017, however, suggests that the FTSE 100 is not immune to the impacts of Brexit. While these large companies are indeed invested outside of the UK, some companies and some sectors may be exposed significantly to the Eurozone and thus may be vulnerable to changes in Britain’s trade relationship with the EU.
The real surprise is the UK small caps. Surely one would expect that the FTSE Small Cap Index would be even more sensitive to Brexit than large and mid caps, yet over these time periods, the UK small cap market has performed well. The FTSE Small Cap Index has a very large percentage of its weight in Equity Investment Trusts (48% as of March 31, 2017). These investment funds are diversified away from the UK domestic economy by virtue of their investment holdings. The Equity Investment Trust subsector of the FTSE Small Cap index returned 23.8% over the period since the Brexit vote in 2016.
Only time will tell how the separation of the UK from the EU will evolve. Although the vote to leave occurred in June 2016, Britain and the EU are still only at the beginning of the process of separation, an event for which there is no precedent. The FTSE indexes will continue to shed light on how Brexit is impacting the United Kingdom, the Eurozone, and, indeed, the world.
See, for example, “FTSE 100 v FTSE 250” AXA Self Investor News and Insights, 17 August 2016: https://www.axaselfinvestor.co.uk/news-and-insights/what-is-the-difference-between-the-ftse100-and-ftse250. Also, Wright, B., “Why we should be looking at the FTSE 250 and not the FTSE 100 to gauge the impact of Brexit,” The Telegraph Business 28 June 2016: http://www.telegraph.co.uk/business/2016/06/27/why-we-should-be-looking-at-the-ftse-250-and-not-the-ftse-100-to/. For a different perspective, see Williams, A., “Does the FTSE 250 really reflect British Economic Health, CitiA.M. Talk, 14 March 2017: http://www.cityam.com/260824/does-ftse-250-really-reflect-british-economic-health.
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