The British stock market is not the British economy
When the British stock market falls, it is either because of Brexit or because the Coronavirus hit the British harder than the rest of Europe. Both statements are nonsense. There is no stock exchange in the world where so many multinationals are listed as in London. As a result, the British stock exchange is more than 80% dependent on developments in the rest of the world. The fact that the British stock exchange (-20%) lags behind the rest of Europe (-7%) is mainly due to the composition of the sector.
For example, the IT sector in the UK weighs only 1%, compared with almost 30% in the United States. The energy and financial sectors are well represented. Energy was 14.4% at the beginning of the year, compared with 4.3% in the United States. That makes quite a difference when such a sector halves in value. The financial sector weighed 20% in the UK at the beginning of the year compared with 10% in the US. In the US, the prices of banks and insurers fell by 20%, Europe-wide by 50%. Correcting for the different sector weightings and poor price performance of European financials, this year’s FTSE 100 stands at -3% and not -20%.
That – 3% for the British stock exchange happens to be equal to the return on the DAX, one of the better-performing exchanges this year. Now, the DAX has been a real laggard in recent years due to the diesel scandal, so that is a good thing. But the DAX is a reinvestment index, so the price return is lower. What is more, the DAX has no energy sector. At the same weighting for the Energy sector as in the UK, the DAX would be more than 7% lower. The DAX does have financials, but Deutsche Bank is a remarkable white raven with a positive return this year. Fortunately, the Germans were able to get Wirecard into the DAX just in time to reduce the return. On balance, the DAX performs worse than the FTSE 100.
There is also a stock exchange that benefits above-average from the sector division, and that is Denmark. The well-performing Pharmaceuticals sector accounts for more than half of the index weight. Denmark has no energy sector and the financial sector weighs only a few percent. What Denmark does have, however, are companies that score well in terms of sustainability, which is another important plus this year. With more than 20% profit, it is the best performing stock market this year.
The British stock market is well-positioned for a cyclical recovery of the world economy and the associated sector rotation. A sharp price correction in IT stocks will not hit the FTSE 100, but there are few exchanges with as many as 11 mining companies in the index. Together with the weighty energy and financial sectors, it appears to be the ideal stock exchange for the counter investor. Coincidentally, a deal on Brexit will have to be made in the next two weeks. If this is really what it is all about, then the shutters will be closed. There will be no more communication with the press. That is usually a sign that an agreement is about to be reached. We only know that the deal has failed when there are accusations from one side to the other.
After four years of Brexit negotiations, it seems impossible to predict the outcome. In such cases, the maxim that even the most unpredictable dictators are surprisingly rational when it comes down to it often helps. Accidents happen, but they are the proverbial exception. A deal between the UK and the European Union would be good news for the British stock market. Again, correlation is not the same as causality. It comes at a time when the excess of cyclical stocks on the British stock exchange is benefiting from the economic recovery of the global economy.