This article was written by Graham Ellinson, a Financial Analyst at I Know First.

FTSE 100 Forecast:

“The truth is the majority of our trade takes place with the European Union. And things like our food industry, you can’t export it to Australia — it will go off.”
— Labour Shadow Foreign Secretary Emily Thornberry’s argument for why Brexit will be devastating to U.K. trade prospects.

Summary:

• At close on 31^st December the FTSE 100 (^FTSE) stood at 6,728.13 down -12.41% over the past year.
• In a recent publication from the Office of National Statistics the UK gross domestic product (GDP) grew by 0.6% in the past quarter.
• While the FTSE is ultimately tied to the underpinnings of the UK economic performance its short-term performance is very often influenced by political factors such as Brexit and general market scepticism.
• Brexit has dominated politics and had a huge impact on the UK economy including the FTSE.
• Brexit has caused significant changes to the pound sterling, not only from key events but from speculation within financial markets.

Source: maxpixel.net

Overview of UK Economy and Look at FTSE

The Financial Times Stock Exchange 100 Index is a share index of the 100 companies listed on the London Stock Exchange with the highest market capitalisation. It is seen as a gauge of prosperity for businesses regulated by UK company law. At close on 31^st December the FTSE 100 (^FTSE) stood at 6,728.13 down -12.41% over the past year. Following a particularly bad December this marks it down as the worst year for the FTSE in a decade.

However, the UK does not stand alone in this with China and the USA also suffering heavy losses across their respective stock exchanges. Moreover, many economic indicators within the UK suggest that the UK economy is robust and has a positive outlook for 2019. While the FTSE is not exclusively linked to the UK economic performance as there are many international companies listed on this index a keen investor will pay close attention to the key UK economic indicators when attempting to understand and evaluate the performance of the FTSE index.

Strong 2018 UK Economic Performance A Positive for the FTSE

In a recent publication from the Office of National Statistics the gross domestic product (GDP) grew by 0.6% in the past quarter. This growth was driven mainly by the services sector, though the production and construction sectors were also positive contributors to this growth.

Furthermore, the 12-month inflation rate in November was 2.2% (CPIH) only 0.2% above the national target of 2%. Additionally, the inflation rate rose to a shock 2.7% in August leading to an interest rates hike from the Bank of England to 0.75%, the highest since it was reduced to 0.5% in February 2009. However, Howard Archer chief economic advisor to the EY Item Club stated that it this inflation rise was fuelled by cultural goods suggesting it was a temporary rise. Nonetheless, over the same period of this August inflation shock wages still rose by 2.9% beating the inflation rate in real terms.

Another critical factor to monitor in economic performance is employment levels. For the UK the October 2018 unemployment rate stood at 4.1%, lower than the 4.3% a year earlier. This illustrates an increasing downward trend to unemployment and overall suggests that 2019 will continue to output robust economic indicators.

While the FTSE is ultimately tied to the underpinnings of the UK economic performance its short-term performance is very often influenced by political factors such as Brexit and general market scepticism. Clearly, the long-term health of the country is what will determine the overall performance. The continued growth in GDP fall in unemployment over 2018 indicates that the foundation of the economy is stable and consequently provide a good indication that the FTSE will remain bullish in the long term.

A Look at the biggest influencers in the FTSE

Source: Flickr

The largest company traded on the FTSE 100 is Royal Dutch Shell (RDSA + RDSB). With Brent Crude falling over the past 3-months by -36.56% it comes as no surprise this would have a significant impact on the FTSE however, most market experts retained a positive outlook on Shell. Another top performer is Diageo PLC (DGE) a huge global alcoholic drinks brand. Experts warned that DGE would suffer with the impending uncertainty regarding whether Britain will remain in the European customs union and seeing as a huge part of revenue comes from its Scotch Whisky, if taxes would be imposed on exports to the EU this would have a significant impact on the profitability in its single malt production and exports. Whilst the outcome of whether the UK will remain in the customs union or not is yet to be seen one thing seems clear the uncertainty that seemingly impacts other companies that are reliant on exports does not seem to have much impact on DGE one of the largest companies in the FTSE.

The Impact Brexit has had on the FTSE

The UK voted in a referendum to leave the European Union in June 2016. This was a long-awaited referendum following growing discontent with relationship Britain had with the EU. The vote was 51.9% in favour of Britain leaving the EU and 48.1% opposed.

Source: Flickr

While it is difficult to truly understand what led to this result many believe it was focused around immigration concerns and not the general health of the UK economy there remains a small portion of leave campaigners that personally believe the UK would be better off taking full control of its sovereignty allowing the UK to negotiate its own trade deals. The outcome of the deal is still a long way off and certainly the economic consequences are even further away however, in the short-term Brexit has dominated politics and had a huge impact on the UK economy including the FTSE in a number of ways. The strength of the pound in its global standing has drastically dropped. This in turn has reduced the cost of British goods and services providing a boost to the FTSE that for the foreseeable future while the Brexit negotiations are occurring will remain unchanged from this position.

What Brexit events have had the biggest impact on the pound?

Brexit has caused significant changes to the pound sterling, not only from key events but from speculation within financial markets. However, these events in particular have had a major impact on the pound.

• Referendum result. Following the vote to leave the EU, the pound fell sharply. In the weeks following the referendum the pound fell by 10.4% against the Euro from €1.3017 on 23 June to €1.1663 on 6 July 2016.
• Article 50 Legal challenge. In October 2016 negotiations took place to determine whether Theresa May could trigger Article 50 without parliamentary approval. It was during this legal battle that the pound fell by 4.6% from €1.1579 on 30 September 2016 to €1.1044 on 11 October 2016. The High Court ruled that the government must have parliamentary approval i.e. a law would need to be passed through the House of Commons and the House of Lords in order to authorise Article 50.
• Single market speculation. The pound fell once again on the 16 January 2017 due to speculation surrounding Theresa May’s hardline approach to Brexit and the expectation that she would announce that Britain will be leaving the EU single market. The pound fell by 3.45% following these reports from €1.1767 Euros on 3 January 2017 to €1.1361 on 16 January 2017.
• Article 50 triggered. Theresa May triggered Article 50 on 29 March 2017. This kick-started the formal process of Britain’s exit from the EU and saw the pound drop by 0.65% from €1.1612 on 23 March 2017 to €1.1537 on 29 March 2017.
• General election results. The sterling suffered its highest fall of 2017 following the surprise election result as Theresa May lost her majority government, sparking more political uncertainty in Britain. The pound fell to a seven-month low of €1.1287.

What seems clear is that the short-term outlook on the FTSE remains exceedingly volatile with exit day approaching in March and investors are still left with no clear understanding how the relationship the UK with have with the EU will operate. The following transition period most exit day in March is expected to be slightly more stable but with the economic ramifications still unclear the FTSE will unlikely outperform other indices such as the S&P 500 for some time.

Conclusion

The FTSE has underperformed over the past few months suffering from a particularly difficult December. The large companies that drive the FTSE such as Shell and Diageo remain strong and are set for continued growth across 2019 in spite of difficult political and global climates. The uncertainty regarding the extent of Brexit and how its relationship with the EU and the rest of the world remains uncertain making the UK a particularly risky investment. This has had a greater impact on the pound rather than British companies, meaning that in fact the FTSE has an inverse relationship with the pound and has improved when the pound drops.  The short-term outlook for the FTSE is volatile and difficult to predict, while the year-long outlook is positive.

Current I Know First Forecast

The current I Know First forecast for the FTSE is neutral for the short-term and bullish for the one-year timeline with a signal of 23.67 and predictability indicator of 0.77.

How to interpret this diagram.

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Please note-for trading decisions use the most recent forecast.