FTSE 250 has rallied 13% since June low, but that’s too much, Goldman says
Stocks in smaller British companies have come back surprisingly well in the aftermath of the Brexit vote — but analysts are warning it’s time to dump those U.K.-focused shares.
The mid-cap FTSE 250 index MCX, +0.20% initially sold off 14% in the days right after the June 23 referendum, but has since staged a 13% rally to 16,995.41. That puts the benchmark within touching distance of its pre-vote level of 17,333.51 — and that premature recovery is sparking concern among equity strategists.
“We would be cautious on U.K. domestic exposure. And given recent performance, we also think the FTSE 250 is vulnerable, especially relative to FTSE 100, which should benefit from weaker sterling,” analysts at Goldman Sachs said in a note dated Tuesday.
The companies listed on the FTSE 250 depend heavily on U.K. economic growth, as about 50% of their sales are generated within the country. That compares to only 20% of revenue for those on the big-cap FTSE 100 index UKX, +0.36% .
That makes the FTSE 100 more attractive when the pound GBPUSD, -0.5598% slumps, as its internationally focused components are likely to benefit from foreign-exchange translations and from a pickup in sales as their products get cheaper for holders of other currencies.
On the other hand, smaller, U.K.-based companies tend to get the cold shoulder when the pound falls, given their domestic focus.
Since the Brexit vote, sterling has dropped more than 10% against the dollar and euro GBPEUR, -0.4421% , and it’s expected to fall further. As for the U.K. economy, this week’s purchasing managers’ indexes signaled a sharp contraction in growth after the referendum. That means the FTSE 250 is now facing a double whammy of downsides.
“Given the recent bounce, the FTSE 250 in year-on-year terms is only slightly negative, and we would argue it is not fully reflecting a U.K. manufacturing PMI at 48; it is more consistent with the PMI having only fallen to around the 50 level,” the Goldman strategists said.
The mid-cap benchmark’s performance is highly correlated to the PMI readings on U.K. manufacturing, as shown in the chart below.
The services PMI reading out on Wednesday also painted a dire picture of the post-referendum economy, slumping to 47.4 in July — the lowest level since 2009. A reading below 50 indicates contraction.
The lackluster data, however, are encouraging hopes that the Bank of England will bring out the big easing bazooka on Thursday , cutting interest rates and restarting its bond-buying program.
That kind of central-bank action typically gives stocks a boost — but Goldman Sachs argues that it’s not a clear-cut case in terms of the mid-caps. If the additional stimulus weakens the pound and pulls Gilt yields lower, the FTSE 100’s blue chips stand to benefit the most, they said.
So which FTSE 250 companies may be in the frame? The Goldman Sachs analysts pointed to real-estate developer Derwent London PLC DLN, -0.75% , Great Portland Estates PLC GPOR, -0.98% and betting company William Hill PLC WMH, +1.92% as companies that make most of their money in Britain.
The also pointed to a bunch of FTSE 100 companies with high domestic exposure: broadcaster ITV ITV, -0.35% , housebuilder Travis Perkins PLC TPK, -1.53% and supermarket chain Wm. Morrison Supermarkets PLC MRW, +2.07% .
Deutsche Bank sees risks, too
Goldman Sachs’s downbeat assessment of the FTSE 250 is echoed by Deutsche Bank, which recommends being underweight the benchmark.
“Our FX strategists expect the [trade-weighed pound index] to weaken by a further 9% by year-end, and economic lead indicators point to a sharp downturn in U.K. growth,” the German bank’s analysts said in a note from Monday.
“As a consequence, we see 10% downside for the FTSE 250 relative to the FTSE 100 by year-end,” they added
They stayed upbeat on the FTSE 100, however, and lifted their year-end target for the benchmark to 6,800 from 6,150 previously.
SOURCE: Market Watch – Sarah Sjolin
