Headwinds for the FTSE

Wednesday, 27th February 2019 07:50 - by Shant

The start of 2019 has been a positive one for stock markets, though put into context, it was more a case of recovering from one of the worst quarters seen into the end of 2018 for well over a decade.  Courtesy of a Fed turnaround, global markets have been placated by assurances that the balance sheet runoff will end before 2019 is over and to boot, rate increases have been put on the back burner until more economic data can be assessed. 

Last year, some may remember my scepticism over some of the projected rate paths which suggested the Fed was on course to hike 4 more times this year - and how spectacularly wrong they were.  Indeed, rates markets have now priced out any moves in 2019, with the benchmark 10yr Treasury Note barely 15bps above short end rates. 

All this comes in spite of the US outperforming the rest of the world on most fronts, though naturally, other factors such as public debt and political stability play their part in investor confidence.  Even so, comparatively speaking, US assets still command favour irrespective of concerns over valuation levels based on the economic outlook for the global economy.  

However, UK stocks face the added complication of how the Brexit process develops and more importantly, how the rest of the market reacts to it.  As we have seen this week, the Pound is now pricing in a reduced risk of a no deal. On the face of it, this is a welcome development for UK businesses, though as we have seen consistently, the inverse relationship with the exchange rate can be detrimental for equities in the UK.  Oversized moves in Sterling - either way - have clear consequences, both for stocks and the economy as a whole.  We saw how inflation was impacted on the Sterling crash below 1.2000, though eventually helped to prop up revenue earners in US Dollars with manufacturing firms enjoying most of the benefits.  

In light of the developments seen in Westminster this week, we now have widespread optimism that parliament will do all in its power to avoid a no deal outcome.  Despite being rejected on countless occasions, the cabinet is refusing to rule out taking a no deal scenario off the table, which would, in essence, render Theresa May's negotiating leverage useless.  Even so, markets are reading between the lines, and suddenly the prospect of avoiding a disruptive withdrawal from the EU looks very much on the cards.  In a market looking for viable alternatives to the US Dollar, we may well see some significant gains in Sterling over coming weeks and months, which investors in UK stocks should be wary of.  At this point, it is worth noting that long term fair value in the Sterling exchange rate with the Dollar stands at 1.4000-1.4100.  A swift return to these levels could have a significant impact on global revenues. 

The other factor to consider in relation to the Brexit talks is that the negotiations on the terms of trade have also yet to be started.  Getting to this point has taken a painfully long period of time and the future relationship with the Eurozone is what no lies beyond the current impasse.  In short, the real negotiations start from this summer, allowing for a possible extension to the withdrawal date.  This in itself is another negative factor, which the PM now seems a little less rigid on.  As is widely acknowledged, any extension to the exit date merely prolongs the period of uncertainty.  Businesses have already spent millions on contingency plans, and these are sunk costs which will have hurt baseline profits.  Business investment may be waiting in the wings, but the UK has already suffered casualties, with Nissan and Honda just two of the more high profile cases.  

Watching levels on the FTSE 100, we saw a modest move beyond the 7200 mark, but this has proved to be short-lived.  Technically, 7250 carries some relevance, marking a key breakdown point in October last year.  We would suggest these levels could prove more pivotal over future direction, but I would suggest watching 1.3300 in the Sterling/Dollar exchange rate.  A meaningful break above here could signal a stronger shift to the fair value levels mentioned above.  This could be a case of 'planets aligning' for a much-awaited breakout in volatility - volatility which has been relatively muted at time of heightened uncertainty for both UK and global markets. 

The Writer's views are their own, not a representation of London South East's. No advice is inferred or given. If you require financial advice, please seek an Independent Financial Adviser.