UK ETFs At Record Highs, Fooling Bearish Forecasters

October 21, 2016

As unexpected as the United Kingdom's decision to leave the European Union was this summer, even more unexpected has been the aftermath.

"Brexit," as the situation was unofficially called, was supposed to wreak havoc on economies and stock markets around the world. Ahead of the referendum, the International Monetary Fund warned that "a vote for exit would precipitate a protracted period of heightened uncertainty, leading to financial market volatility and a hit to output."

But instead of seeing this dire scenario unfold, the events post-Brexit have actually been positive.

For one, the United Kingdom economy continues to hold up, with no sign of a recession on the horizon. In fact, the IMF now says that the U.K. may end up being the fastest-growing G-7 economy of the year.

Meanwhile, aside from a brief two-day sell-off immediately after the vote, equities have largely rallied in the months following Brexit. To the bewilderment of many, the U.K. stock market hit an all-time high earlier this month.

Pound Fuels UK Stock Surge

Analysts attribute the surge in U.K. stocks to the sinking British pound. Just a few weeks ago, the pound hit 31-year lows against the U.S. dollar on concerns that Prime Minister Theresa May was leaning toward a "hard Brexit," in which the government would prioritize restricting immigration at the expense of trade access to the European Union single market.

British Pound Sterling

 

Currency traders pushed down the pound amid fears of higher trade barriers at the same time that equity traders bid up stock prices in anticipation of higher earnings for multinationals. The U.K.'s multinationals are reaping the benefits of a lower currency as their exports become more competitive and their overseas profits become worth more when translated back into pounds.

Year-to-date, the MSCI United Kingdom Index is up 16.1%, well ahead of most other developed-market countries. However, the largest U.S.-listed U.K. ETF, the iShares MSCI United Kingdom ETF (EWU), is actually down 3.2% in the period, due to the enormous slide in the British pound against the buck.

To capture the rally in U.K. stocks, investors in U.S.-listed ETFs would have had to buy currency-hedged products such as the iShares Currency Hedged MSCI United Kingdom ETF (HEWU)―up 15.6% year-to-date―or the WisdomTree United Kingdom Hedged Equity Fund (DXPS)―up 20.7%. (For more U.K. ETFs, see our United Kingdom ETF Channel.)

 

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