Why the FTSE 100 at a post-Brexit high is not necessarily good news

FTSE 250 offers a better indication of the UK economy

Investors have been bargain hunting on the FTSE 100, buying up shares that had fallen in value
Investors have been bargain hunting on the FTSE 100, buying up shares that had fallen in value

The FTSE 100 has hit a 10-month high, recovering from Brexit losses less than a week after markets took a pounding from the UK's shock decision to leave the EU.

The pound has also strengthened against the dollar and the euro, appearing to rally further (momentarily) after Boris Johnson's surprise announcement that he would not be running for Tory leadership.

By Wednesday, four trading days after the result, the FTSE 100 beat its pre-Brexit high of 6,338.1 at the close on Thursday June 23, just hours before referendum polls closed.

By the close on Friday it was trading higher still at 6,557.83.

Why is the FTSE 100 rallying?

After heavy losses on the FTSE 100 following the referendum results, investors took heart from the decision by policians to delay invoking Article 50, effectively delaying any further upheaval.

Investors started bargain hunting, buying up shares that had fallen in value.

"There is a confidence within the City that perhaps the implications to this vote may not be as immediate nor far reaching as many initially thought, providing opportunities for bargain hunters to grab shares at a discount," said Joshua Mahony, IG analyst.

Funding injections from the Bank of England, intended to shore up the UK financial sector, buoyed the market.

Then Mark Carney, Governor of the Bank of England, hinted he may cut interest rates below their historic low of 0.5 per cent. That would make it cheaper for banks to borrow money that they can then lend out for higher rates.

Why hasn't the pound also rallied?

The pound, which fell to 31-year lows after the results came out, has stabilised since but is trading signficantly lower than it was before the vote.

After hitting a low of $1.3148 against the dollar on Monday, it is now fairly flat at $1.3284.

That's bad for holidaymakers looking to make their money go further abroad.

But it is helping confidence in the FTSE 100 companies. The majority of FTSE 100 constituents are multinational companies that make a large proportion of their income overseas. As the pound drops in value, this income is worth more in the UK.

Cheap sterling can also reduce imports to and increase exports from the UK.

Why isn't the rallying FTSE 100 necessarily good news?

To get a better indication of the UK economy, it is helpful to look at the FTSE 250, or the 250 biggest companies in the UK, which is more dependent on the UK economy than the multinational companies represented in the FTSE 100.

The FTSE 250 fell 13 per cent in two days after the vote came in. It has recovered a little since then, but not on the scale of the FTSE 100. By close on Friday it was trading at 16,465.49, some way off its pre-Brexit high of 17,333.51 on Thursday June 23.

Confidence in domestic companies is low because the outlook for the UK economy doesn't look good. There's a much higher risk of recession, according to Standard & Poor's, who put the likelihood of recession in the next 12 months between 20 and 25 per cent, compared to 15 and 20 per cent in March.

George Osborne, the Chancellor, has abandoned his target of reaching a budget surplus by 2020. That will come as a relief to those who believe greater public sector spending will be necessary to address the knock on effects of the slowing economy.

But it's another indication that the UK's economic recovery has been derailed by the vote to leave the EU, despite how things seem on the FTSE 100.

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