Can the FTSE 100 Benefit from Brexit?

Britain’s vote to “Brexit” — or to leave the EU — has struck financial markets like a tsunami, capsizing more than USD$3 trillion in capitalization and dragging funds down to the murky depths of depreciation. Therefore, it may sound impossible — and even comic — to suggest that the FTSE 100 benchmark could actually benefit from the impending Brexit. But as the saying goes, there’s more to this than meets the eye.

Brexit’s Impact on the FTSE 100

Thus far, the Brexit vote has one clear result: it’s been highly negative for the Pound. In fact it’s been so negative that, just hours after the completion of the Brexit referendum, the Pound took a nose dive of 10%, falling to a 30-year low against the Dollar. Further, with the Bank of England on standby to inject greater liquidity into the economy and perhaps even cut rates, it is likely that the Pound will stay low for a while.

How does that relate to the FTSE 100, the index for the largest 100 companies on the London Stock Exchange? Well, exporter-oriented companies, such as energy or pharmaceutical firms, gain revenue in foreign currency when their stocks trade in pounds. The lower the Pound, the higher the firms’ revenues and stock values. This may end, though, because UK-manufactured goods, such as clothing and food, are now cheaper — which could, in turn, increase demand for them. The magnitude of currency fluctuations depends on whether FX hedging measurements have been set in place (through different fx treasury services).

However, there’s another factor to consider. To accurately project the impact of the weaker pound on the FTSE 100, we need to analyze the dominant sectors in the index. The reason? Some sectors are worse off under a weaker pound, or they are overly exposed to bank losses.

In the chart pictured below, the export-sensitive sectors that benefit from a weaker pound are rendered in green, while the sectors that suffer from a weaker Pound appear in light orange. When we compare the benefiting sectors with the vulnerable ones, we get an interesting result.

Overall, 54% of the FTSE 100 benefits from a weaker Pound, while the remaining 46% is vulnerable both to a weaker Pound and to Brexit. Despite that, another concern remains. While the graphic shows that the FTSE 100 benefits overall from a lower Pound, the benefit is not enough to overcome a major sell-off in the Brexit-sensitive sectors.

For the FTSE 100 to actually gain from a weaker Pound, the fallout from Brexit must not be too severe. Otherwise, even if a majority of the index’s sectors benefit, the rest is subject to a massive sell-off, which could drive the pound down too far — to the point of a dangerously low valuation.

The good news is that Brexit, in actual terms, has not yet occurred, and it’s not expected to be implemented before October, at the earliest. This delays the real economic impact of Brexit, even as the Pound remains weak.

Should investors realize that the Brexit vote is not a clear-cut financial disaster, and the true economic shock is not that severe, their sell-off in the Brexit-sensitive sectors will weaken, leaving the sectors that benefit from a lower pound to thrive — and the FTSE 100 to rebound.

While fundamental analysis is helpful in mapping the trajectory, technical analysis is the key to time a price movement, in our case - a rebound. Examining the FTSE100 chart, we can see the FTSE100 touched the 5,500 low briefly and rebounded back to 6,165. For the FTSE100 to truly rebound 2 things must occur. First, the 5,500 low must be retested. If the 5,500 holds, it will be established as support. The second, momentum must switch from bearish to bullish. A good gauge for momentum is the Stochastic Oscillators Momentum Index. Once the SMI Signal line is above the blue line, it is a signal that momentum has reversed. Once the Stochastic Momentum Index will suggest a turnaround and the 5,500 will be established as support the likelihood of an upcoming rebound for the FTSE100 will increase.

Of course, nothing is guaranteed, and the situation could become more volatile. But if things remain as they are — with Britain’s exit from the EU pushed off for several months, giving the market time to turn bullish again — then the FTSE 100, contrary to popular belief, can not only bounce back, but even gain from the looming Brexit.

Luis is a business writer and financial analyst. With over 15 years of experience in global finance and an MBA in economics and management, Luis’s areas of expertise include business, marketing, communications, personal finance, macro economics, stocks and emerging markets.