Stock markets are strong…
The strong performance of UK stock markets since the referendum on EU membership can be seen as a vote of confidence by investors in the future prospects for the UK economy. The decline in sterling immediately after the vote provided a boost to export oriented sectors such as life sciences and food, and beverages and tobacco, while there was a negative impact on several sectors focused on the domestic market such as house building and retail. Overall, the net effect was for the market to move upwards immediately after the vote.
The market held on to its gains and has continued to move upwards. At the start of March 2017, eight months on from the vote, the FTSE 350 was up over 13% and the majority of sectors had moved into positive territory. The sectors that benefited from the immediate reaction to the referendum vote have advanced further and they have been joined by others such as automotive, technology and banking – sectors that were initially seen as being potentially negatively exposed to Brexit. The majority of sectors now have values higher than before the vote with telecommunications the outlier, having fallen by nearly 10% more than other sectors. However, it appears that this decline reflects industry specific issues rather than explicit nervousness about the impact of Brexit.
…so all’s well?
The headline numbers suggest that the market is increasingly confident about the UK’s ability to prosper both in the run up to, and after Brexit. The fall in the exchange rate and the Bank of England’s policy response may have influenced the value of the stock market, but a rise of over 15% in eight months is nevertheless a significant positive move.
Maybe, maybe not…
It is the case though that in US dollar terms the FTSE 350 market has not increased by anything like the same amount, being a little over 5% up compared to more than 15% in sterling terms. Maybe investors are not as confident in the UK as the headline numbers might suggest? Is there anything more than a currency boost in the numbers? What do we find when we dig a little deeper?
…as the devil is in the detail…
Our detailed analysis suggests that the headline numbers may not be telling the full story. When we look at the Enterprise Value to EBITDA multiples (EV/EBITDA), a favoured metric of my corporate finance colleagues, further analysis of which on this issue you can read on the Capital Agenda Blog, we find that the ratios have declined for six sectors over the last 12 months and increased for six others, clearly the market perceives relative changes in the future prospects for individual sectors. A decline in the multiple suggests that the market is concerned about the ability of businesses in these sectors to grow in the future at the rate it felt was possible a year ago.
The move in EV/EBITDA ratios varies across the sectors, the main declines have been of around 25% in the retail sector, 20% in basic resources and 8% in media and personal and household goods. The largest gains were in industrial goods and healthcare at around 8-10%. A number of factors might explain the changes in these rankings, but on first sight it does appear that sectors closely tied to the performance of the UK domestic economy have been marked down and those more aligned with external sales have increased.
…and the more we look, the more we find…
There was an overall decline in the multiple of the UK base compared to Europe of around 10% compared to a year ago. This does suggest that, contrary to the widely held view that the increase in the UK market since the Brexit vote is a vote of confidence in the UK’s prospects, there is concern about the UK’s growth prospects relative to Europe.
When we compare multiples in UK companies against their European peers over the last year, it confirms the view that geographic exposure is a key influence on the changes in the multiples being used by investors to appraise certain sectors in the UK. In this data we find that the multiples for only three sectors have improved in the UK relative to their European peers, healthcare, industrial goods and oil and gas, while nine have fallen in relative terms. The nine includes the sectors identified above that have fallen in the UK, together with technology, real estate and travel and leisure, all of which have experienced significant declines in their multiples relative to Europe.
The sectors that have declined relative to Europe are those most exposed to the UK domestic economy and the gainers are the more externally oriented sectors. This is the same story as with the relative shifts across sectors in the UK market with the consumer sectors in particular being marked down significantly.
This difference between the performance of businesses with a domestic compared to external market focus is also apparent when we look at indices that separate these two effects out at an aggregate level. As shown below, the relative performance of externally oriented businesses is clear.
…so this is a good time to take stock.
Drawing detailed conclusions from overall stock market performance is always difficult but there is clearly a risk that overall average performance may mask issues at a sector level. It is clear that taking the appreciation in UK stock markets since the Brexit vote as a sign that all is well is too simplistic. While the market is up overall, it is also the case that the data shows that there is relative apprehension about the prospects for the UK domestic economy relative to Europe. It does appear that investors are more concerned about the UK’s relative growth prospects than they were a year ago.
The appreciation in the ranking of externally oriented stocks may also not be all good news. Or at least, it reflects a significant bet on the ability of the UK to secure favourable trade deals with the EU and other countries after Brexit. There does appear to be the risk of a significant correction in externally exposed stocks if the UK is less successful than the market appears to believe it is likely.
With the UK close to triggering Article 50 and signs that the UK economy may be reacting to the changes in recent months as inflation rises and retail sales and business investment slow, now is the ideal time to review future business plans for signs of risk and opportunity and to identify how these could impact shareholder value. Certainly, relying on the headlines and assuming the economists who forecast a slowdown as a result of Brexit were wrong and not developing contingency plans is a very brave approach.