1 week on from the historic vote, and it’s becoming increasingly clear that the UK’s economy is set to take a hit from the momentous decision to leave the EU. It’s obvious that after 40 years of being inside the world’s largest trading bloc, we’re geared for being there, not outside it. So there will be a transition period during which the UK will not have favourable ties to Europe and this gap will not be filled by extra trade deals with the rest of the world. That’s a fact.

However, this isn’t all that clear from the point of view of stock markets. While the UK mid-cap index ( ) is still languishing some 6% down year to date, the UK 100 blue-chip index is currently threatening a potentially massive 900pt rally to take it to new all-time highs north of 7100. Of course we know that the UK 100 derives some 70% of earnings from outside the UK, and so its exposure to the UK economy is less than that of the 250 (which is 50% dependent on the UK economy). However, with all this talk of global contagion, the potential implosion of the EU post-Brexit (which won’t be for a few years yet, if at all) and a stronger US Dollar hampering demand for commodities, shouldn’t market sentiment see us expecting more of a worldwide slump?

The Brexit Effect?

                  Technicals on the UK 100 indicate a potential 900pt rally to new all-time highs could be on the cards

Well, yes. However, a look at the biggest contributors to the UK 100 ‘s week-long rally throws up a list of multinational defensive stocks, oil majors and gold miners! The reason for this is not risk aversion as such – if it were then oil majors would probably be underperforming given that crude oil is sensitive to global growth concerns. In fact, it can be largely attributed to the weak Pound Sterling. The stocks currently influencing the UK 100 the most report in USD, but they’re listed in the UK for tax purposes (let’s not get into the tax thing here…).

This means there’s a foreign exchange benefit for these companies in terms of earnings when they convert USD to GBP. While this is unlikely to get investors wet in terms of capital gains, speculative income seekers will see things differently in terms of EPS. Heightened demand naturally attracts the growth investors as a result.  That’s why stocks such as British American Tobacco (BATS), Diageo (DGE), BP (BP.) and Royal Dutch Shell (RDSb) are outperforming.

Having said all of the above, it’s important to note that this is not inherrently a ‘risk-on’ rally. This is a rally based solely upon the weak GBP and global economic stimulus hopes. With the BoE now widely expected to cut UK interest rates this summer, the GBP’s burden could become even heavier, strengthening the USD further and seeing that select few blue chip stocks continuing to buoy the UK 100 . It’s not exactly wholesome nourishment, more like an isotonic sports drink.

Whether more of the same central bank intervention we’ve seen since 2009 (rate cuts, QE) serves to assist the ‘s exporters too, safeguarding or even creating jobs and boosting wage growth and inflation, or simply tempts more speculators into the UK’s flagship index, remains to be seen.

Augustin Eden, Analyst (1 July)