The FTSE 100 has risen 47 points after yesterday’s general election. Given the surprise result, many investors may be wondering why the index is up at a time when political instability is higher than it has been for some time. After all, Theresa May now has a smaller majority even when counting on the support of the DUP. This means that her government could be viewed as having been weakened ahead of the Brexit talks that are due to begin shortly.
International vs domestic exposure
As has been the case since the EU referendum in June 2016, the FTSE 100 has benefitted from its international status. Although its constituents are listed here in the UK, they are mostly exposed to economies outside of the UK and, in many cases, Europe. This means that their earnings carry significant currency risk, which has worked to their advantage in recent months following the depreciation of the pound.
Since the election, the pound has weakened. It is down around 2% versus the US dollar. This is good news for the FTSE 100, since it means international earnings gain a positive currency translation. That’s the key reason why the FTSE 100 is up at the present time, rather than down to reflect the political uncertainty which the UK now faces.
Looking ahead
While the FTSE 100 has risen following the election to a level close to its recent high, it does not appear to be too late for investors to buy into it.
Of course, the political risk facing the UK remains exceptionally high – even after Theresa May has met the Queen and formed a minority government/struck some kind of deal with the DUP. Minority governments are usually relatively weak governments, since they are ultimately unable to pass legislation as they wish without the support of other parties.
With Brexit talks set to commence shortly, the risk of difficulties for a minority government is exacerbated. Even within the Conservative Party there are major differences on how Brexit talks should progress. Therefore, the chance of an ineffective government which is essentially impotent are increased.
This could lead to greater political risk, possibly another election and, crucially, a weaker pound. As mentioned, a depreciation of sterling would be good news for the FTSE 100, and could help it to make record highs over the medium term.
Global risks
While the UK economy is one of the largest in the world, the reality is that the FTSE 100’s future outlook is more closely aligned to the performance of the global economy. With China’s transition towards a more consumer-focused economy continuing to gather pace and the US on the cusp of higher spending which could boost its economic growth rate, the global macroeconomic outlook remains relatively positive.
Coupled with weaker sterling, this could create ideal conditions for further rises in the value of the FTSE 100. Therefore, even with political risk now higher in the UK, buying the FTSE 100 could be a shrewd move.
