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How to trade UK stocks as election ends in political deadlock

Shares of U.K. companies focused on the domestic market could tumble in the wake of the shock hung parliament result in the country's general election while shares in export-oriented U.K. companies could see a further rally, according to Deutsche Bank.

Sterling fell precipitously as soon as exit polls released at 10 p.m. London time on Thursday suggested that incumbent Prime Minister Theresa May and her Conservative party would struggle to cobble together anything more than a razor thin majority. The actual results confirmed those fears.

By 6 a.m. London time on Friday, with a hung parliament confirmed, sterling had fallen by around 1.5 percent against the U.S. dollar to sit at $1.2754, having fleetingly ticked up just above the $1.30 level as recently as May 19.

This outcome is likely to lead to a repeat of the dynamic seen in the immediate aftermath of the Brexit vote last June, in which export-oriented U.K. stocks benefited from a drop in sterling while more domestically-focused companies responded more poorly to the heightened prospect of economic and political instability, the research analysts said in a note published on June 6. A weaker currency boosts the earnings of an exporter once converted back into the local currency.

Describing the prospect of a Conservative minority government or a hung parliament as "the key risk scenario" in a research note published on Tuesday, the Deutsche Bank team warned that this outcome could lead to higher macro uncertainty.

"Our macro analysts expect the GBP to sell off sharply and Gilts (10-year U.K. government bonds) to fall to 0.9 percent in this scenario (from the current 1.05 percent). Defensive exporters with little domestic exposure but high GBP-sensitivity are likely to outperform, while domestic consumer plays are likely to be hit by the increase in political uncertainty," said the note, with its authors going on to suggest mining, healthcare and energy companies, such as BP, Shell, Rio Tinto and Shire could be winners. The U.K.'s FTSE 100 was up by 0.9 percent as markets opened on Friday morning.

Turning to likely potential losers, the analysts pointed to domestically-oriented consumer retail names such as Kingfisher, Next, Dufry and M&S as well as certain property plays such as Hammerson and INTU.

"Retailers would likely underperform as a consequence of FX-driven inflation, higher cost of goods sold, uncertainty about the legislative agenda, and greater risks of hard Brexit … Any weakness in the retail sector should also likely weigh on retail-focused real estate," predicted the analysts, before turning to the financial sector and singling out Lloyds, RBS and Aldermore as names upon which to keep a wary eye.

"Increased political uncertainty due to a close election outcome would be a negative for domestic banks, in particular relative to their U.K.-based, globally-focused peers (HSBC, Standard Chartered)," according to the research.

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The divergent fortunes of domestically focused and export-oriented stocks in the wake of the Brexit vote is well understood by looking at the FTSE 250 index and the FTSE 100 index as respective proxies.

The FTSE 100, whose constituent companies earn around 70 percent of their profits from overseas, experienced a much shallower downturn immediately following the Brexit vote and has enjoyed a more substantial rise in the eleven months since than did the domestically-oriented FTSE 250.

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