Deutsche Bank Says Hung Parliament Outcome Likely To Cause Slump In Domestic UK Stocks

According to Deutsche Bank, while shares in export-oriented U.K. companies could see a further rally, in the wake of the shock hung parliament result in the country’s general election, shares of U.K. companies focused on the domestic market could tumble.

As soon as it was suggested that incumbent Prime Minister Theresa May and her Conservative party would struggle to cobble together anything more than a razor thin majority in exit polls released at 10 p.m. London time on Thursday, the sterling fell precipitously.

sterling had fallen by around 1.5 percent against the U.S. dollar to sit at $1.2754, by 6 a.m. London time on Friday, with a hung parliament all but confirmed.

After the Brexit vote while more domestically-focused companies responded more poorly to the heightened prospect of economic and political instability, export-oriented U.K. stocks benefited from a drop in sterling in the immediate aftermath of the Brexit vote last June, and this election outcome is likely to lead to a repeat of the dynamic seen then, the research analysts said in a note published on June 6. Once converted back into the local currency, a weaker currency boosts the earnings of an exporter.

The Deutsche Bank team warned that this outcome could lead to the increased risk of a hard-Brexit and higher macro uncertainty while describing the prospect of a Conservative minority government or a hung parliament as “the key risk scenario” in a research note published on Tuesday.

“Our macro analysts expect the GBP to sell off sharply and Gilts [10-year U.K. government bonds] to fall to 0.9% in this scenario (from the current 1.05%). Defensive exporters with little domestic exposure but high GBP-sensitivity are likely to outperform, while domestic consumer plays are likely to be hit by the increase in political uncertainty,” said the note, with its authors going on to suggest mining, healthcare and energy companies, such as BP, Shell, Rio Tinto and Shire could be winners.

Domestically-oriented consumer retail names such as Kingfisher, Next, Dufry and M&S as well as certain property plays such as Hammerson and INTU, would probably be the likely potential losers, the analysts pointed out.

“Retailers would likely underperform as a consequence of FX-driven inflation, higher cost of goods sold, uncertainty about the legislative agenda, and greater risks of hard Brexit…Any weakness in the retail sector should also likely weigh on retail-focused real estate,” predicted the analysts, before turning to the financial sector and singling out Lloyds, RBS and Aldermore as names upon which to keep a wary eye.

“Increased political uncertainty due to a close election outcome would be a negative for domestic banks, in particular relative to their UK-based, globally-focused peers (HSBC, Standard Chartered),” according to the research.

By looking at the FTSE 250 index and the FTSE 100 index as respective proxies, it is easy to understand the divergent fortunes of domestically focused and export-oriented stocks in the wake of the Brexit vote.

The FTSE 100 has enjoyed a more substantial rise in the eleven months since than did the domestically-oriented FTSE 250 and experienced a much shallower downturn immediately following the Brexit vote as it’s constituent companies earn around 70 percent of their profits from overseas.

(Adapted from CNBC)

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