FTSE 100 or FTSE 250: where is the smart money headed?

Since the EU referendum, the FTSE 100 (INDEXFTSE:UKX) has risen, while the FTSE 250 has fallen. The key reason for this is the exposure of the stocks within the two indices, with the FTSE 100 containing companies that are more international and less reliant on the UK than companies listed on the FTSE 250.

Therefore, with investors being nervous regarding the future prospects for the UK economy following the referendum result, it’s logical that the FTSE 100 has gained a boost while the FTSE 250 has come under pressure. That’s especially the case since companies in the FTSE 100 are more likely to benefit from weak sterling, with a loose monetary policy over the medium term by the Bank of England as it seeks to boost the UK’s economic output.

Why? This will, of course, produce a positive currency translation for companies reporting in sterling but operating abroad. Those companies are more likely to be trading in the FTSE 100 rather than the FTSE 250. Therefore, it would be of little surprise for the FTSE 100’s outperformance of the FTSE 250 in recent weeks to continue.

Long time to leave

Beyond that, the FTSE 100 could beat the FTSE 250 over the longer term. That’s because Brexit will be a very prolonged and uncertain process. While we now have a new Prime Minister, it will take at least two years for the UK to leave the EU and in that time negotiations will be likely to have dominated news headlines and caused investors to become increasingly nervous regarding the UK’s future.

During such a time, the international focus of the FTSE 100 could be seen as a lower risk option for investors wishing to remain in equities. And once the negotiations are completed, the UK will then have to go it alone outside of the EU, which is likely to exacerbate investor fears to an even greater extent than during the negotiation phase. That’s because we simply don’t know how the UK will fare in a post-Brexit world.

On the one hand, the UK could perform well and deliver continued economic growth as has been the case in recent years. However, leaving the EU could lead to job losses as companies and individuals invest less in the UK and move jobs abroad. In the first scenario, the FTSE 250 would be likely to perform well, but it could struggle to keep up with the FTSE 100 in the latter scenario.

Therefore, the smart money seems to be headed towards the FTSE 100 at the present time. After all, there are a number of high quality companies trading on appealing valuations. Certainly, the FTSE 250 contains a number of excellent stocks that could deliver stunning capital gains. However, their share prices are likely to remain volatile over the medium term and, as ever, picking companies with wide margins of safety is likely to be the key to long-term investor success.

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Peter Stephens has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.