Article By: Shrey Srivastava
When the bombshell arrived last week that 51.9% of our country voted to leave the European Union, the prognosis for the FTSE 100 looked bleak. Indeed, on Friday itself, the index initially fell by as much as 8.7%, wiping off almost a tenth of its total value.
The financial sector was among the hardest hit, with shares of banks such as Lloyds Banking Group dropping by as much as 19.93%. All the cards were in place for a further drop in the index, so in characteristic stock market fashion, the FTSE surged and reached 6577.83 on Friday, reversing completely the drop made last Friday. This unexpected rise isn’t just due to investor irrationality, however; there are some solid fundamentals behind why the FTSE 100 rose this much, and these fundamentals also mean that there is reason to believe that the index could rise even higher. Another sustained gain such as that seen this week could, indeed, see it push beyond the 7122.74 intra-day high made at the end of 27 April last year; it’s definitely within the realm of possibility, especially given the recent actions of the Bank of England.
On Thursday, the governor of the UK central bank, Mark Carney, suggested that the Bank of England may cut interest rates to levels below the 0.5% of today, given Brexit concerns and uncertainty. Intuitively, this decreases the rate at which banks can borrow money, making borrowing cheaper for these financial institutions. Coupled with the £3.1 billion cash injection into the UK’s banking system, the future for banks operating within the UK became a little brighter, causing shares of banks such as Barclays to rise. Given that financial institutions constitute a major proportion of the FTSE 100 companies, this boost to their immediate and future prospects caused their share prices to appreciate not just on Thursday but also on Friday, in turn causing the FTSE to rise by a considerable amount.
Whilst there remains considerable doubt over the long term prospects of banking given the worldwide recession which some reputable economists are forecasting, the Canadian’s actions will go a considerable way to ensuring their short-term prosperity in the event when a Brexit finally materialises later down the line. Thus, there is solid reason to believe that banking shares could rise in value, hence causing the FTSE to upswing in the same vein.
After our country sensationally voted for Brexit, many were sure that Cameron would immediately trigger Article 50, beginning our withdrawal from the juggernaut trade bloc. Instead, he announced that he was to resign as Prime Minister in October, plunging both his party and the future of our country as a member state of the EU into a multitude of uncertainty.
The subsequent race for the next leader of the Conservatives is overwhelmingly likely to be won by the Home Secretary Theresa May, who has a reputation for prioritising safety and stability above radical change. Her comments in her recent speech that if she were to become Prime Minister, Article 50 would not be triggered by the end of the year also meant that, at least for some months, companies who would be drastically affected by a Brexit (ergo, most of them) have some degree of certainty regarding their short-term future prospects. In addition to this, the fact that once Article 50 is triggered a Brexit would likely take up to 2 years to materialise, ensures that these companies have some time in which to decide on their future prospects, and to formulate a plan for when the inevitable exit from the EU finally happens. This means that they will be ready for the short-term economic consequences of the event, and with knowledge of this, investor sentiment towards these companies could heighten, causing both their individual share prices and the FTSE 100 to rise.
Given that the constituents of the FTSE 100 are almost exclusively large-cap transnational corporations, a large amount of their revenue is earned from abroad. Carney’s aforementioned comments and the short-term economic pounding that would ensue following our European exit have caused the British pound to decline and to be projected to decline in future; our credit rating downgrade from S&P has done nothing to alleviate this. On Friday, after a staggering initial drop following the EU referendum and Carney’s comments Thursday, the pound was worth $1.33, a far cry from the $1.48 it was worth last Thursday.
This sudden and large drop in the value of the pound means that the value of the revenue of the multinationals comprising the FTSE suddenly increases, in terms of the pounds. For companies that display revenue on balance sheets in terms of the pound, this increased revenue could be seen as a strong sign of potential future success by investors, thus perhaps causing the share prices of these companies and the FTSE 100 as a whole to appreciate. In a world where no one really knows what’s going to happen next, at least big business can do well, right?