This year has not been kind to major stock markets around the world. However, the United Kingdom’s FTSE 100 has shown remarkable resilience. What is driving this extraordinary performance? Is this reflective of the broader UK economy?
First among its peers
The FTSE 100, a stock market index that represents the 100 largest companies listed on the London Stock Exchange, is widely used as a measure of the UK’s economy’s strength.
The FTSE 100 has performed better in 2022 than other European stock indices such as France's CAC, Germany's DAX, and Spain's Ibex. It has also performed better than major US indices such as the Dow Jones, Russell 2000, S&P 500, and Nasdaq.
The reason behind this divergence is the distinctive stock composition of the index, which includes a high concentration of defensive sectors such as mining, energy, and utilities. These sectors have been largely immune to volatility, and have also benefited from a commodities super-cycle and a weaker pound. This has translated into higher dividend payouts, and an overall boost to the index's performance.
The weaker pound has contributed because many FTSE 100 components generate revenue outside the UK and report their profits in pounds: hence, a weaker pound has increased those reported profits. Companies with higher profits have, all else equal, higher stock prices, driving the index higher.
The impact of a weaker pound on the FTSE 100 had already been seen following the Brexit vote in June 2016. After the vote, the pound significantly depreciated against other major currencies, leading to a temporary drop in the FTSE 100. However, the index eventually recovered, even reaching all-time highs, thanks to the profit boost explained before.
Additionally, the FTSE 100 index is heavily weighted towards cheaper sectors, such as banking, mining, and tobacco. But, despite this year’s difference in performance, last November we saw the widest valuation gap between the FTSE 100 and the S&P 500. One potential explanation for this could be investor concerns about the impact of a weaker pound on company margins, as inputs become more expensive. However, these worries may have dissipated lately, given that the US dollar has lost power, and productivity in the US has grown. Another possible factor: foreign investors often prefer to invest in the US due to the larger and more liquid investment opportunities available there. In other words, they may not find there is much to gain on the margin by tilting their portfolios towards more UK exposure.
FTSE 100: Not the same as UK economy
However, the FTSE 100 does not tell the complete story of the UK economy. In sharp contrast to it, the FTSE 250, an index representing the 101st to 350th largest companies listed on the London Stock Exchange, has experienced a decline of approximately 20% year-to-date. This performance is more in line with that of other major European and US stock indices, whereas the FTSE 100 has remained relatively unchanged year-to-date. The largest companies listed on the London Stock Exchange have vastly outperformed mid-sized firms.
Firms on the FTSE 100 generate around three-quarters of their revenue abroad. For firms on the FTSE 250, the number hovers around one-half. In terms of performance, when comparing against the S&P 400, its American equivalent, the FTSE 250 is not currently an outlier.
Although the FTSE 100 has performed well in 2022, we have some concerns regarding future performance. First, the index does not include medium- and small-sized companies, and has limited exposure to emerging industries like technology, which reduces its ability to adapt to changing market conditions. Additionally, uncertainty about inflation and interest rates are weighing more heavily on markets at the moment than considerations about the strength of particular companies within an index. Thus, we should expect other indices to recover as these macroeconomic worries dissipate.
In fact, some analysts have stated that the FTSE 100's strong performance is just indicative of a temporary "value rally". The distinctive makeup and lack of exposure to certain industries of the FTSE 100 may hinder its long-term prospects.
To conclude, the FTSE 100 has had a great year, largely due to its defensive stocks and the rise in commodities’ prices. However, the index could suffer in the near future for the very same reasons behind its year-to-date outperformance. Moreover, its success in 2022 hardly mirrors the performance of most companies across the United Kingdom.
The S&P 500 is an index of 500 large-cap stocks listed on the New York Stock Exchange or the NASDAQ, designed to represent the performance of the overall U.S. stock market.
The S&P 400 is an index of mid-cap stocks listed on the New York Stock Exchange or the NASDAQ, designed to represent the performance of mid-sized U.S. companies.
The Nasdaq is a stock market index that represents the performance of over 3,000 publicly traded companies listed on the NASDAQ stock exchange.
The Russell 2000 is an index of small-cap stocks listed on the New York Stock Exchange or the NASDAQ, designed to represent the performance of small-sized U.S. companies.
The Dow Jones is an index of 30 large, publicly traded companies listed on the New York Stock Exchange and the NASDAQ, designed to represent the performance of the overall U.S. stock market.
The CAC 40 is an index of 40 major French companies listed on the Euronext Paris stock exchange, designed to represent the performance of the overall French stock market.
The Deutsche Boerse AG German Stock Index DAX is an index of the 30 largest and most liquid German companies listed on the Frankfurt Stock Exchange, designed to represent the performance of the overall German stock market.
The IBEX 35 is an index of the 35 most liquid Spanish companies listed on the Bolsa de Madrid stock exchange, designed to represent the performance of the overall Spanish stock market.
The FTSE 100 is an index of the 100 largest and most liquid companies listed on the London Stock Exchange, designed to represent the performance of the overall UK stock market.
The FTSE 250 is an index of the 250 mid-cap companies listed on the London Stock Exchange, designed to represent the performance of mid-sized UK companies.
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