Long ReadJan 25 2023

Why is the FTSE 100 performing so well?

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Why is the FTSE 100 performing so well?
The FTSE 100 delivered a positive return in 2022, even as the MSCI World Index lost around 13 per cent. (FT Montage)

The FTSE 100 reaching near all-time highs at a time of double digit inflation, anaemic economic growth and sharply negative consumer sentiment seems counter intuitive, but the latest dawn may prove to be a false one, according to several professional investors. 

Around three-quarters of the earnings of the UK’s large-cap index come from overseas, meaning the index generally performs in a way not especially linked to the performance of the domestic economy. 

The FTSE 100 actually delivered a positive return in 2022, even as the MSCI World Index lost around 13 per cent. 

2022 was a good year for the UK’s largest companies.Darius McDermott, Chelsea Financial Services

Darius McDermott, who advises on the VT Chelsea range of multi-manager funds, says: “2022 was a good year for the UK’s largest companies. While almost every other major stock market experienced declines, the FTSE 100 rose 4.7 per cent over the calendar year.

"The big drivers of performance in the FTSE 100 have been the mega caps – the 20 or so very largest companies in our stock market."

He adds: "These companies, particularly those in the healthcare and the oil and energy sectors, have benefitted from being global businesses and dollar earners – so when the dollar has appreciated against the pound it has been to their advantage.

"AstraZeneca, for example, has seen its stock price rise by more than 30 per cent over the past 12 months, while the likes of Shell, BP, Rio Tinto, and Glencore are up 49 per cent, 50 per cent, 32 per cent and 57 per cent respectively.”

If inflation has peaked, then it is likely that the sectors which are a big part of the FTSE 100 would be expected to do less well.Richard Saldanha, Aviva Investors

As all commodities such as oil and steel are priced in dollars wherever in the world they are traded, and when the dollar is strong against sterling, this means the value of the dividends paid by commodity companies in sterling rises. 

Those sectors performed well on other global markets as well, but it is the FTSE 100 that has a relatively larger exposure to areas such as banks and oil companies.  

Richard Saldanha, a global equity income fund manager at Aviva Investors, says that while the composition of the index has helped the FTSE of late, he is cautious on the outlook for the UK market because the very trends that have helped it may be receding. 

He says the market is starting to believe that inflation globally may have peaked, and therefore that interest rates may not rise to the levels previously expected, and this has led to generally improved investor sentiment in both bond and equity markets.

The fund manager adds that the re-opening of the Chinese economy has also contributed to the improved sentiment. 

China’s re-opening may stave off recession, which would be a positive for equities, but may also mean inflation sticks around longer.Ben Yearsley, Fairview Consulting

But Saldanha notes "if the market is right and inflation has peaked, then it is likely that the sectors which are a big part of the FTSE 100 and which do relatively better in times of higher interest rates, such as banks and commodity companies, would be expected to do less well. The oil price has already fallen from its highs”.

He adds that China re-opening may increase the level of global economic demand, which may be inflationary, and mean that inflation persists in defiance of investors' current expectations, which might be expected to dent sentiment towards equities in a general way. 

Ben Yearsley, investment director at Fairview Consulting, says the dilemma faced by equity investors is that China’s re-opening “may stave off recession, which would be a positive for equities, but may also mean inflation sticks around longer, which would be negative”. 

Market makers

He says the composition of the UK index, with lots of stocks exposed one way or the other to the vagaries of inflation, means the impact of China’s reopening will be acutely felt by investors in the domestic market. 

Yearsley says that the UK market will be more likely to outperform in circumstances that are closer to those of 2022, when market participants continued to expect interest rates to rise than in the conditions that the market currently expects, which is a pivot away from interest rate rises. 

Simon King, chief investment officer at Vermeer Partners, is another who is slightly bemused at the performance of the FTSE 100 so far in 2023. 

On the UK and Europe specifically we find it difficult to get excited about the underlying economies.Simon King, Vermeer Partners

He notes: “We are expecting a tough first half so are a little surprised by strength of markets in recent weeks. Our concern is that it may be the first half of a suckers rally, that is: everybody is more optimistic and wants to focus on good news, but when that stops and they inevitably focus on the bad bits of the news the market goes into reverse.

"In short, we would not chase it. On the UK and Europe specifically we find it difficult to get excited about the underlying economies, with the UK government balance sheet looking so weak and with elevated inflation, and the [European Central Bank] so far behind the curve.

"However, the sector make up – that is, big on financials, health, energy and industrials – suits the current market since these are the areas people want to buy.”

McDermott is a little more optimistic on the outlook for UK equities as he feels the strengths of the market have been under-appreciated for many years and so there is potential for this to change. 

Rates of change

He adds that even though inflation is falling, and interest rates may not rise to the levels previously expected, both are likely to be higher in the coming year than they have been for most of the past decade, and that should boost the relative performance of the FTSE 100 compared with markets that contain fewer of the sectors that tend to do well when inflation is higher, such as the US. 

But even in that context, McDermott prefers the UK mid and small-cap parts of the market right now, saying that those companies had suffered such stark share price falls in 2022 that they may have further to advance this year. 

Given the extent to which UK clients tend to be exposed to the UK stock market, its performance will doubtless have an outsized impact on advisers fortunes in 2023.

David Thorpe is investment editor at FTAdviser