Where is the FTSE 100 heading to amidst a Pound rally and uncertainties of the general election?

Where is the FTSE 100 heading to amidst a Pound rally and uncertainties of the general election?

The broader equity index of the London Stock Exchange, the FTSE 100 has shown a general lack of trend since the General Elections (GE) were announced on October 28, 2019. On the other side, the domestic assets have recorded a decent surge since the date of the GE announcement.

FTSE 100 ended October 28, 2019 trading session at 7,331.28 and traded 1.3% lower compared to the October 28, 2019 closing level to end the day’s session at 7,233.90 on December 09, 2019. On the other side, domestic mid-cap stock index, the FTSE 250, has so far has rallied 3.4% during the same time period. The British currency (GBP) has rallied approximately 1.6% against the US dollar in the same time period and was hovering above its crucial support level of 1.30.

Do not forget the FTSE 100’s inverse relationship with GBP

FTSE 100 comprises of a substantial number of internationally focused businesses and a sharp surge in the British currency would diminish their earnings that are generated abroad and translated into Pounds. Therefore, what is considered suitable for the UK economy is technically negative for the FTSE 100 stocks and very positive for domestic stocks or the FTSE 250 index, because their earnings are sourced majorly in Pounds.

As we have witnessed since the date of the GE announcement, sterling has recorded sharp recovery and we have also witnessed a sharp recovery in mid-cap index FTSE 250. But the same trend is missing in case of the FTSE 100 index. Also, we have seen that the Dollar Index contracted during the same period.

General election uncertainties

With opinion polls throwing up trends indicating PM Boris Johnson's victory in the December 12 general election, it has strengthened the British currency as well-bolstered sentiment for the domestic stocks. With one more day left for the UK's general elections the market would remain volatile over the potential outcome of the same. Since 2015, this is the third general election that the UK is going to witness. However, past general elections had surprised the market with their outcomes; the situation is still very unpredictable this time as well.

The biggest benefit with PM Johnson-led Conservative Party is that this time it has a deal, which could be very influential in the upcoming elections. Also, it is widely recognised that now it is high time to fix this Brexit impasse, which is affecting the entire economy of the United Kingdom.

If PM Johnson comes back with the absolute majority, it is widely expected that Britain would crash out of the EU block by January 31, which is official date for Brexit by virtue of the deal PM Johnson has already negotiated with the EU block. Then both sides could fine tune a trade deal by the end of 2020. This made one thing clear that no-deal Brexit is now off the table, which came as a big boost for GBP and as well domestic stocks.

Long-beaten down domestic stocks have recently shown some sign of resilience which is primarily supported by the surge in the GBP.

A surge in domestic currency would reduce import bills for the UK's domestic companies, minimise international debt-related obligations, and other international obligations would also reduce.

Therefore, we see that there is a direct relationship between the movement in GBP and performance, of domestic stocks. Since the Brexit referendum took place, Pound had tumbled substantially, and UK's domestic stocks were weighed down because of this.

If there is a Hung Parliament

According to opinion polls, if the Conservative party fails to bag a majority in favour, then the second most probable scenario is that of a Hung Parliament in which no party enjoys an absolute majority. This is again going to put Brexit in the doldrums, which would have significant weighing down effect on the GBP, and we could experience GBP trading below 1.30 against the US dollar once again.

This would be worst for UK's domestic stocks; however, a fall in the GBP would support FTSE 100 rally as it will again open headroom for the FTSE 100 stocks for foreign exchange translation gains. However, the long-term effect of this could be bad for both domestic as well as for international stocks listed in the UK.

US-China trade deal has more to do for FTSE 100 companies

Since the last one and a half years, the trade war between the world's two largest economies US and China has deteriorated the global sentiments, demand and investments. Many economists have claimed that the US-China trade war is the root cause behind the prevailing global slowdown. Banks are in bad shape, non-performing assets are mounting up across the world, credit offtake is slow, and demand has slowed down across the globe. This has impacted businesses globally; however, companies with global market penetration are in worser shape than domestic market-focused businesses.

Also, in the past, we have witnessed many classical signals which in recent months have heightened chances of a recession, ranging from continuous contraction in global GDP, erosion of jobs and US Bond yield inversion.

We know that FTSE 100 companies are more international market-focused businesses and so they are also facing a lot of challenges.

If US and China can fix phase-1 of the trade deal in next couple of days, this would be a stimulus for the FTSE 100 companies as well, as this would help to bring back demand in the market for their products.

Analysis of FTSE 100

Daily price chart (from October 28, 2019 – December 09, 2019). Source: Thomson Reuters.

In the above chart, it is depicted that the FTSE 100 performance post the announcement of the General Election is negative. However, recently after US President Donald Trump signed the Hong Kong Bill, which further stoked the rifts between the two largest economies and raised concerns over phase-1 trade deal, FTSE 100 witnessed steep plunge during the same period. However, post that incident, both US and China have taken a softer stance over Phase-1 trade deal. This has provided some sort of positive sentiment in the market and FTSE 100 index has also recovered in the past couple of trading sessions.

Therefore, we expect that a phase-1 trade deal between the US and China in near future would have positive sentiments across the globe would have a more favourable impact on the FTSE 100 stocks.

Conclusion

In the wake of rising British currency post favourable outcome of the December 12 snap elections and trade dispute remaining unresolved between the US and China, the FTSE 100 could head lower in the near term. However, the mid-cap gauge FTSE 250 could record decent surge if things go as forecasted.

For a breakout in the FTSE 100 index, it required that a phase-1 trade deal between the US and China are on the table, which could boost the top-line and earnings of its constituent companies.

Also, recovery in the global banking industry would boost FTSE 100 financials, which is at present tough to estimate. Declining interest rates globally would weigh on their interest income and interest margins as well, especially during the time when credit offtake is low.

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