UK mid-caps: not such a pounding

The day after the EU referendum, the FTSE 250 index of mid-cap UK stocks fell 14 per cent in two days. Seen as the best proxy for British economic activity, it was a lightning rod for fears about a post-Brexit slowdown. Those fears remain, despite a startling recovery in the index.

By the end of the year, the mid-cap index was trading 20 per cent above its late-June nadir. This is in part due to the resilience of the UK economy, especially the consumer-facing parts like retail sales, personal lending and housebuilding. But a deeper look shows that most of the gains in the second half were down to commodity stocks and foreign-exchange plays.

Of the £10bn or so net increase in the FTSE 250’s market value since late June, over half has come from the basic materials sector: stocks such as Evraz, Vedanta Resources and Kaz Minerals. Industrials, many of which are heavily exposed to overseas revenue, have also risen. Another sector with net gains is financials. That includes investment trusts such as Scottish Mortgage, which often have large holdings of dollar-denominated assets. In most years, stripping out the trusts boosts the FTSE 250’s gains; this year, including them did so.

The weaker pound is not a durable source of earnings improvement. By the middle of next year, the translational effect will start to drop out of comparisons. The commodity price rally may also provide only a temporary boost. That would leave the more traditional, UK-facing sectors doing the heavy lifting in 2017. Consumer goods, services, telecoms, technology and utilities shed a combined £5bn in the second half of 2016. That might yet prove to be overdone; after all, UK employment levels remain high while credit is cheap and easy to access.

One test will be the expected re-emergence of inflation and its effect on real wages and spending. Another will be the mood music around the Brexit process as the government starts the clock on EU withdrawal. Still, the nation’s shopkeepers, builders and publicans have proved equal to such challenges in the past — mid-caps have beaten blue-chips in seven out of the past 10 years.

Email the Lex team at lex@ft.com