Is the FTSE moving into bubble territory?

What do the stock and currency markets tell us about the widespread claims before the referendum that Brexit would mean financial and economic disaster? And how seriously should we take suggestions that the FTSE is now moving into bubble territory, as we heard from the famous UK fund manager Neil Woodford over the weekend?

Let us start with the FTSE 100 viewed in the way that makes it look bubble-icious, and also appears to reject totally any idea that Brexit was bad for the UK economy, in isolation and denominated in pounds.

The share market has recovered significantly since the shock of referendum night, even though sterling has moved on to further lows since then. It is difficult to dismiss that recovery as solely an effect of money illusion.

Also, and importantly, the FTSE 100 has put in a strong performance when compared with gilts. Investors are making a classic bet, in usual times at any rate, that Brexit will lead to inflationary growth — good for stocks and very bad for bonds.

It is only when we compare the FTSE 100 to the rest of the world that Brexit begins to look as though it has done serious damage to UK assets. Yes, in pounds, the FTSE 100 has delivered a nice return of late. But the sterling return for investing outside the UK over the past year would have been more than 10 percentage points better. All of that underperformance has happened since the referendum.

Further, the performance of the FTSE 250 — medium-sized companies not big enough for the FTSE 100 — is revealing. Around much of the rest of the world, smaller companies have been outperforming, but not in the UK. This is probably because smaller companies are much more directly affected by the UK economy.

Why are multinational stocks doing so much better? This turns out to be almost entirely thanks to the global recovery in materials stocks. Since the referendum, 38 FTSE 100 members’ share prices have fallen, in sterling terms. The gain has been strongly driven by a remarkable recovery for materials stocks, led by Glencore.

Over the past year, the FTSE 100 has been led by the rebound in materials stocks. Internationally, according to MSCI, materials and miners have far outstripped the FTSE. Meanwhile, UK materials stocks (including miners outside the FTSE 100) have done far better still. They have doubled in the past 12 months, in dollar terms.

That said, share prices appear to be running ahead of commodity prices, and their recovery does seem overdone.

The impact of Brexit on global miners such as Glencore is tiny. It is therefore fair to say that the FTSE 100’s rally says little or nothing about the economic impact that Brexit will have. Many stocks are down since the referendum, despite the buoyant conditions for stocks globally, and the UK lags behind the US severely. Brexit has certainly not caused the financial disaster that many warned against. But so far the evidence is that it has been treated negatively by markets. UK share prices would probably be higher now if the referendum result had been different. What the longer term impact on the economy and asset prices will be remains unknowable.

Is it fair to say that prices are in a bubble? A number of indicators suggest the FTSE is expensive. Price/earnings multiples are as high as they have been in 20 years, bar the top of the boom in 2000 and a brief period when profits crashed after the Lehman crisis. Other measures show a similar pattern.

However, it is difficult to call this a bubble. Energy and materials companies have depressed earnings thanks to low materials prices. They are (reasonably) being priced on the assumption that oil and metals prices will rise over time, and so the p/e would be expected to be higher than usual.

If we use a cyclically adjusted p/e multiple, as calculated by Research Affiliates, where UK share prices are compared to average earnings over the past 10 years, then UK shares appear to be almost exactly in the middle of the range. Their current p/e is 13, and the median p/e since 1969 has been 14.

For the time being the huge devaluation in sterling has been enough to buffer UK asset markets against other problems. UK equities seem reasonably valued, although the rebound in the miners may well have got a little ahead of itself.

john.authers@ft.com