Following the recent £24bn bid for ARM Holdings, many investors may be wondering whether a flurry of bid activity is around the corner for the FTSE 100 (INDEXFTSE: UKX). After all, sterling has weakened by around 10% since the EU referendum and as a result, UK-listed companies are suddenly cheaper to buy for foreign investors.
Clearly, the valuation appeal of the FTSE 100 has improved since the EU referendum, although the index’s price level has increased by 6% during the same time period. Therefore, there’s limited additional appeal following the EU referendum in terms of the price of FTSE 100 companies. Of course, with the index yielding over 3.5%, it remains historically appealing from a value perspective.
Looking ahead, there’s scope for a further weakening in sterling in the coming months and this could increase the appeal of the FTSE 100 for foreign investors. This seems likely for two reasons. Firstly, the Bank of England has stated repeatedly that there are significant risks facing the UK economy. Therefore, a further reduction in interest rates is very much on the cards as policymakers attempt to boost the UK economy.
Secondly, the risks surrounding Brexit remain high and this could cause fear among investors to increase. Theresa May has indicated that she won’t invoke Article 50 of the Lisbon treaty in the near future, which means that the UK is unlikely to leave the EU before 2019 at the very earliest. This will undoubtedly cause the increased fear and uncertainty among investors to rise further, which may lead to another fall in the value of sterling.
High value
Of course, even if sterling falls, the rising value of the FTSE 100 could offset this. For companies reporting in sterling, a weaker currency will lead to a positive translation boost to earnings and as has been the case since the referendum, the price level of the index may therefore rise. And with uncertainty regarding the short, medium and long-term performance of the UK economy being high, some foreign investors may adopt a ‘wait and see’ attitude in the coming months and years.
However, even if the UK economy’s performance deteriorates in future, the reality is that most FTSE 100 earnings are derived from abroad. Therefore, it’s very much a global index and both domestic and foreign investors may be more interested in the progress being made by the US and China, rather than how the UK’s macroeconomic outlook appears.
And with the benefits of a weak currency potentially being offset by higher valuations as positive currency translations have an effect, the potential for increased M&A activity in the FTSE 100 may be limited in a post-Brexit world. In fact, little may change, with deals such as ARM’s £24bn bid continuing to be the exception, rather than the rule.