UK ETFs At Record Highs, Fooling Bearish Forecasters

The Brexit vote was supposed to be unambiguously bearish for stocks, and particularly U.K. stocks. Instead, they surged.

sumit
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Senior ETF Analyst
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Reviewed by: Sumit Roy
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Edited by: Sumit Roy

As unexpected as the United Kingdom's decision to leave the European Union was this summer, even more unexpected has been the aftermath.

"Brexit," as the situation was unofficially called, was supposed to wreak havoc on economies and stock markets around the world. Ahead of the referendum, the International Monetary Fund warned that "a vote for exit would precipitate a protracted period of heightened uncertainty, leading to financial market volatility and a hit to output."

But instead of seeing this dire scenario unfold, the events post-Brexit have actually been positive.

For one, the United Kingdom economy continues to hold up, with no sign of a recession on the horizon. In fact, the IMF now says that the U.K. may end up being the fastest-growing G-7 economy of the year.

Meanwhile, aside from a brief two-day sell-off immediately after the vote, equities have largely rallied in the months following Brexit. To the bewilderment of many, the U.K. stock market hit an all-time high earlier this month.

Pound Fuels UK Stock Surge

Analysts attribute the surge in U.K. stocks to the sinking British pound. Just a few weeks ago, the pound hit 31-year lows against the U.S. dollar on concerns that Prime Minister Theresa May was leaning toward a "hard Brexit," in which the government would prioritize restricting immigration at the expense of trade access to the European Union single market.

British Pound Sterling

 

Currency traders pushed down the pound amid fears of higher trade barriers at the same time that equity traders bid up stock prices in anticipation of higher earnings for multinationals. The U.K.'s multinationals are reaping the benefits of a lower currency as their exports become more competitive and their overseas profits become worth more when translated back into pounds.

Year-to-date, the MSCI United Kingdom Index is up 16.1%, well ahead of most other developed-market countries. However, the largest U.S.-listed U.K. ETF, the iShares MSCI United Kingdom ETF (EWU), is actually down 3.2% in the period, due to the enormous slide in the British pound against the buck.

To capture the rally in U.K. stocks, investors in U.S.-listed ETFs would have had to buy currency-hedged products such as the iShares Currency Hedged MSCI United Kingdom ETF (HEWU)―up 15.6% year-to-date―or the WisdomTree United Kingdom Hedged Equity Fund (DXPS)―up 20.7%. (For more U.K. ETFs, see our United Kingdom ETF Channel.)

 

YTD Returns For EWU, HEWU, DXPS

 

Bearish Forecasters Not Backing Away

The way events unfolded following Brexit, with economic growth holding up better than expected and stocks surging, has been surprising. Still, though many economists and analysts have been wrong so far, they haven't backed away from their views that Brexit will ultimately prove to have negative effects for the U.K.

The IMF, for instance, forecasts that economic growth in the U.K. will slow to 1.1% in 2017 as Brexit uncertainty "weighs on firms' investment and hiring decision and consumers' purchases of durable goods and housing.

That said, the IMF cautions that "Brexit is very much an unfolding event―the long-term shape of relations between the United Kingdom and the European Union, and the extent to which their mutual trade and financial flows will be curtailed, will likely become clear only after several years."

That's because the process of leaving the European Union hasn't even begun. Prime Minister May says she will trigger Article 50 of The Lisbon Treaty by next March. That will begin a two-year timeline in which the U.K. will slowly extricate itself from the EU.

It's not clear when any negotiations on new trade deals will take place and what shape they will take. Optimists believe the U.K.'s trade position after Brexit won't be much worse than it is now; pessimists believe the U.K. going its own way will take a significant toll on trade access, and by extension, the economy.

Don't Underestimate UK
On the one hand, with so much uncertainty regarding the U.K. economy, it might be prudent to be cautious on U.K. stocks. On the other hand, that caution has cost investors an opportunity to participate in a massive rally in the U.K. stock market and currency-hedged U.K. ETFs in the four months since the Brexit vote.

The key points that bearish U.K. forecasters missed were the resilience of the nation's economy and the positive effect of the pound's slide on corporate profits. Both these factors shouldn't be underestimated going forward.

Contact Sumit Roy at [email protected].

 

 

Sumit Roy is the senior ETF analyst for etf.com, where he has worked for 13 years. He creates a variety of content for the platform, including news articles, analysis pieces, videos and podcasts.

Before joining etf.com, Sumit was the managing editor and commodities analyst for Hard Assets Investor. In those roles, he was responsible for most of the operations of HAI, a website dedicated to education about commodities investing.

Though he still closely follows the commodities beat, Sumit covers a much broader assortment of topics for etf.com, with a particular focus on stock and bond exchange-traded funds.

He is the host of etf.com’s Talk ETFs, a popular video series that features weekly interviews with thought leaders in the ETF industry. Sumit is also co-host of Exchange Traded Fridays, etf.com’s weekly podcast series.

He lives in the San Francisco Bay Area, where he enjoys climbing the city’s steep hills, playing chess and snowboarding in Lake Tahoe.