By Josephine Mason and Saikat Chatterjee
LONDON (Reuters) - Shares in London's UK-oriented businesses, such as house builders and retailers, could rocket to record highs if parliament approves the government's Brexit deal, investors say. They also predict the pound will rally around 5%.
British companies that earn most of their revenues at home have been shunned by investors more or less since the 2016 Brexit referendum, as more than three years of uncertainty damaged Britain's economic prospects.
Sealing the deal now, however, could send the second-tier FTSE 250 index, a closely watched barometer of Brexit risk, surging around 5%, an informal poll of analysts by Reuters showed.
"If the deal is agreed (by parliament), there will be more upside on rates, equities and forex," said John Normand, head of cross-asset fundamental strategy at JP Morgan. "The stock market may move up 5%, that will be the domestic names, which are not exposed to currency strength."
Normand reckons sterling could strengthen up to 5% while UK shares rise as much as 10% by the end of the year.
Parliament will debate on Saturday the last-minute agreement between Prime Minister Boris Johnson and the European Union. But Johnson's opponents in the legislature are trying to force a Brexit delay or another referendum. He also lacks a majority, meaning the deal may fail to pass.
But even then, investors don't see too much downside for the pound and domestic UK shares, because the UK seems to have averted the worst-case scenario of crashing out of the EU without agreeing a Brexit transition deal.
That's pushed sterling around 5% higher in the past week while the FTSE 250 has risen more than 6%.
Approval would remove some of the uncertainty that has eroded confidence in UK Plc and pushed share prices and the pound to trade at a big discount to global peers. Large overseas funds that have steered clear of the UK since the June 2016 referendum may return.
Allocations to UK equities dropped to record lows of 7.46% last month, according to Copley Fund Research, which tracks more than 400 funds with $800 billion in assets under management. That compares with an average of around 9.2% before the referendum.
The FTSE 250 (FTMC) could rise 5%, pushing close to record highs above 21,000 reached in April 2018, according to 16 analysts polled on stocks. Half the stocks in the midcap index get their revenue at home.
For the pound, 23 financial institutions polled by Reuters predicted on average that it would rise to almost $1.34 -- nearly 4% above current levels. The most bullish predicted the currency would hit $1.40.
"Investors are still short (sterling) and simply covering those shorts will push sterling above $1.30," Normand added.
GRAPHIC: GBP Positions - https://fingfx.thomsonreuters.com/gfx/mkt/12/7322/7253/GBP%20Positions.png
GRAPHIC: FTSE valuations vs global rivals - https://fingfx.thomsonreuters.com/gfx/mkt/12/7578/7509/FTSE%20valuations.png
"UNINVESTABlE"
Parliament's approving the agreement would mean UK equities were no longer "uninvestable", according to brokerage Bernstein.
It has also moved to an "overweight" on European stocks, naming a Brexit resolution as a "catalyst to bring money back into European equities."
Already this week, investors have pounced on the most beaten-down British stocks, from banks like RBS (L:RBS) to house builders and retailers Persimmon (L:PSN) and Next (L:NXT).
The UK midcap stocks index hit one-year highs on Thursday and last Friday soared more than 4% for its best day in more than nine years.
GRAPHIC: FTSSE 250 and Brexit vote - https://fingfx.thomsonreuters.com/gfx/mkt/12/7577/7508/FTSE.png
Listed British stocks aren't out of the woods yet, however.
First, the likelihood of parliamentary approval appears slim. Northern Ireland's Democratic Unionist Party, which props up Johnson's minority government, said it would oppose the deal.
Deutsche Bank (DE:DBKGn) puts the chances of rejection at 55%. A rough poll of 44 analysts in Reuters' Global Markets forum found an even split between those that think the deal will pass and those that do not.
And even if the agreement is passed, the reality of navigating life after the European Union will set in. Businesses and the economy will also need time to recover from the damage inflicted by prolonged political tumult.
"Even if Boris Johnson does manage to close the deal, investor celebration of this might soon be dampened by the recognition that this is a fairly hard Brexit," said Paul O'Connor, head of the multi-asset team at Janus Henderson.
"The UK now faces a long period of weak economic growth, regulatory uncertainty and political scuffling with our largest trading partner," he added.
That is reflected in currency derivatives, where gauges of expected price swings in sterling are near the highest in more than three years.
GRAPHIC: GBP derivatives - https://fingfx.thomsonreuters.com/gfx/mkt/12/7514/7445/GBP%20derivatives.png
One thing is clear -- the recent dramatic gains in London's tarnished markets have illustrate the pent-up appetite among investors ready to bet that the worst of the political turmoil in the world's fifth-largest economy may be drawing to a close.
