JPMorgan Dismantles Wall Street's Wisdom on the U.K. Stock Rally

(Bloomberg) --

JPMorgan Chase & Co.’s guru on capital flows has demolished a key pillar of the bull case for U.K. assets in the wake of the election.

There is in fact little pent-up demand for British equities among foreign investors -- allocations have long recovered from the calamitous Brexit vote in 2016, according to research from Nikolaos Panigirtzoglou and his team. Their conclusion calls into question an article of faith held by City bulls who see an extended rally thanks in large part to weak positioning.

Add the pound entering overbought territory with fresh signs that short-covering in the FTSE 250 Index is over, and the relief rally that greeted the Conservative Party landslide last week may be on its last legs.

“While 2016 saw heavy outflows from U.K. equities, these outflows got largely reversed in the subsequent years,” the JPMorgan team led by Panigirtzoglou wrote in a Friday note. “We find little evidence of foreigners reducing their allocation to U.K. equities since the Brexit referendum.”

British assets from the currency to domestic stocks have staged a stellar comeback this quarter amid expectations a clear Tory victory will lift political uncertainty over Brexit and spur investment. While bulls talk up billions on the sidelines overseas, JPMorgan suggests it’s a non-starter.

The strategists conclude that after adjusting for the falling share of U.K. stocks in global indexes, fund managers have actually maintained an overweight position. The bank also cites data showing inflows into U.K. shares in 2017 and 2018 after redemptions in 2016, as well as the British government’s own figures concluding that the percentage of local shares owned by foreigners has stayed steady.

JPMorgan’s analysis runs counter to Wall Street consensus including Bank of America Corp.’s fund-manager surveys showing large U.K. underweights and Morgan Stanley’s bullish stock calls citing low positioning.

There are other reasons why U.K. equities may struggle to rally further powered by catch-up potential. Household allocations have held steady since the referendum. Short positions on FTSE 250 futures relative to the large-cap FTSE 100 gauge are also near early 2016 levels, suggesting expectations for a soft Brexit are priced in, according to JPMorgan.

The bank’s projection that sterling is rallying too fast is a more consensus call. A short-term momentum signal has entered overbought territory after the pound reached an 18-month high versus the dollar on Friday, a more than 9% jump this quarter alone.

The post-election relief trade with staying power may be in shorting gilts. A long-term momentum signal for U.K. government bonds remains in overbought territory while a short-term indicator is now negative, JPMorgan’s analysis shows.

The 10-year yield has risen some 37 basis points from a record low reached in September.

To contact the reporter on this story: Justina Lee in London at jlee1489@bloomberg.net

To contact the editors responsible for this story: Sam Potter at spotter33@bloomberg.net, Sid Verma

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