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July 14,2016

“Brexit Boom,” declared yesterday’s Daily Express. The right-leaning British tabloid was celebrating the rally in the stock markets, as the FTSE 100 entered bull territory despite the “doom” claims of “Project Fear.”

It is believed that the newspaper was alluding to the pessimistic prognostications of those who’d preferred to stay part of the EU, even if assessing the fairness of their chosen epithet lies beyond the scope of this article. It was right in a key respect. The markets have soared in the wake of the referendum, with the FTSE 100 extending its gains to over five percent since June 23rd, when a little over half of the U.K. electorate voted to leave the EU.

The bull market terminology reflects the fact the index is 20 percent higher since its February low. In the Express’s reading, the rally is the markets’ vote for Brexit, a poke in the eye for anyone who said a divorce with the union would bomb the U.K. economy.

The newspaper isn’t alone in its verdict. It is an argument that should be familiar to anyone frequenting the Leave-ier corners of the Twittersphere. “Forecasts of a disaster for sterling, equities and interest rates have not been proven correct,” according to the more measured words of former financier Andrea Leadsom, who on Monday stood aside as Theresa May’s sole challenger for leadership of the ruling Conservative Party.

Yet setting aside for a moment the question of whether the equity markets are a good gauge of the nation’s economic health, it’s not always entirely clear what they’re saying.

The U.K.’s flagship equity index does look, in the chart above, to have shrugged off the referendum result. Yet of the U.K. stock indexes, “the FTSE 100 is probably the least representative of Brexit sentiment,” according to Deutsche Bank AG Strategist Thomas Pearce.

Owing to London’s status as an international finance center that’s either sacrosanct or now at grave risk, depending on who you ask, the companies listed in London aren’t all based in the U.K., and the U.K. may not account for a major source of their revenue. FTSE 100 companies get the vast majority of their revenue from outside the British Isles, according to Pearce; so the same company would now be worth more in pounds, which have weakened.

It also happens that the nature of a lot of the FTSE 100 mega-caps is “defensive,” in that they sell the consumer staples for which demand isn’t so sensitive as for the broader range of companies tracked in other indexes. The U.K.’s more cyclical stocks include mining companies, which have rallied with commodities in recent weeks, but for reasons that have little to do with Brexit.

“The FTSE 100 shouldn’t be used. But the FTSE 250 could,” Pearce said. The companies listed there get only a third of their sales internationally, and the index shows quite a different post-Brexit trend.

It’s down more than three percent since the referendum.

One thing these indexes do have in common is that their shares are denominated in pounds — and as the pound’s value plummets, you need more of those weaker pounds to buy a share in a company, all else being equal.

This is the FTSE 250’s value measured in dollars.

That means if you’d bought into a fund that tracks U.K. stocks on the 23rd you’d have less money now, when you go to change those gains back into your home currency (or as a Brit, when you try to travel or invest abroad). That holds true for almost every form of tender, given that the pound’s 11 percent post-Brexit plunge is by far the steepest among 31 major world currencies (since June 23, only Sierra Leone’s leone has lost more value).

So exchange rate effects are helping the rally, as is the composition of the FTSE 100. For Guy Foster, head of research at Brewin Dolphin Ltd, the rally has another meaning.

“The current rally is reflection of a weaker discount rate (i.e. lower bond yields) being worked into valuations models,” he said in an email yesterday. “That decline in yields tells you that markets think the U.K.’s departure from the EU will be negative for economic growth, and by implication inflation and wages. Still, a company that makes, say, branded toiletries for the international market won’t sell any less because of Brexit.”

With almost three quarters of economists who responded to a Bloomberg survey after the vote saying the economy is likely to slip into recession, what’s good for U.K. consumer stocks may not be good for U.K. consumers.

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