Left behind by the rally that ensued following the vote to leave the EU, UK domestic facing shares have outperformed their multinational peers over the last week.
UK stocks outperform
Companies who generate a large proportion of their revenue in the UK have significantly underperformed since June 24th. Fears of a UK economic slowdown drove investors to the exit in the immediate aftermath and shares remained stubbornly low.
However, in contrast to the first weeks after the Brexit, these UK facing stock are now outperforming the wider market. This juxtaposition can be attributed to a number of market dynamics and could very well have some way to run.
Weaker Pound
The pound sank as news hit of a leave victory in the early hours of June 24th. It is yet to recover to levels in excess of 1.4000 against the dollar.
But it is worth noting that hasn’t dropped much below 1.3000, as some analysts had predicted. Investors, who piled into pound denominated dollar yielding assets of multinationals in the expectation of sterling decimation, may grow fearful.
A GBP/USD rate 1.2000 would be a significant boost to earnings of companies such as Unilever and Reckitt Benckiser as dollar earnings are repatriated. The market has jumped the gun on this slightly.
Rich Valuations
Companies achieving significant revenues in dollars have very quickly found themselves trading at a notable premium to those that don’t.
By looking at the forward price-to-earnings ratios of FTSE 100 companies you will see many traditional defensive stocks are changing hands at multiples in excess of 20.
This defies traditional equity valuation methods which price assets based on expectations of future returns.
You would expect blue-chip companies in defensive sectors to have relatively benign growth outlooks and multiples to match. Nevertheless, this is model has become distorted since June 24th.
Dollar generating defensives are trading on valuations typically attributed to high growth tech stocks. Innovative and progressive UK facing FTSE 250 stocks are priced for bankruptcy.
This divergence presents both opportunities and risks. Valuation distortions can persist but have never lasted for ever – the last week is evidence of this.
This article is written by a financial professional. His views are his own and not representative of his company. His comments are not financial advice or a recommendation. He or his clients may own assets discussed in this article.