You may have seen the bright shiny headlines that the FTSE100 is at an all-time high. This was followed by attaching propaganda to the headline explaining that the UK economy is in fantastic shape.
Matching the UK economy to the FTSE100 is the equivalent of using me as a barometer for tall, dark-haired men. I am also 16 years older than the FTSE100.
The reality? The FTSE100 has virtually no meaningful reflection to the UK economy at all. To believe so is confirmation bias in the extreme. The FTSE250 or FTSE Allshare are better examples, but not perfect.
The FTSE100 is simply a club of the biggest businesses who decide to list on the FTSE100 ranked by their market capitalisation. They could just as easily list on Wall Street.
These are multinational giants exposed to global markets and raking in revenues overseas and then repatriating that money back to the UK in sterling.
A strong dollar, or euro v sterling, will mean that when the profits from overseas are brought back into the UK, the profits are exaggerated because of the exchange rate. Low sterling equals higher profits.
The US is currently battling stubborn inflation and ‘rate drop’ hopes have been dampened with the potential for rate rises, which boosts the dollar, and thus the exchange rate between the dollar to sterling.
UK inflation has fallen close to the Bank of England target, opening the possibilities of earlier rate drops in the UK which can weaken sterling, which in turn again helps those FTSE100 companies repatriating their profits. Around 75% of these companies have their revenues earned in dollars so you can see how the sterling/dollar exchange rate exaggerates profits.
The FTSE100 is also highly skewed toward those super valued companies and small movements in big companies equals a distorted index response.
Energy companies have dined out on the UK taxpayer over the last few years, and their gains have catapulted the FTSE100, hardly reflective at all of the UK economy, when in reality they are crushing it, because of the inflation they create in food prices, deliveries and energy as a whole. A rise in oil prices because of global political instability boosts energy companies’ profits but what has that to do with a domestic UK economy?
Finance and pharmaceuticals are two other sectors with heavy weightings in the FTSE100 that can provide disproportionate returns in comparison to the domestic returns (both up and down).
So, when the media are being used to boost the good feeling in the UK, (maybe an election is coming) which are the best indices to compare to understand the UK market better?
The FTSE250 contains those companies listed 101 to 350 in terms of capitalisation, which is a more accurate barometer of the UK domestic market and how UK customers are spending, businesses are investing, consumer confidence, and how government policies are affecting the local markets. It also contains a wider range of sectors and varying industries with less concentration in any single sector.
The FTSE Allshare covers a broader spectrum again with nearly 600 companies from the FTSE100, FTSE250 and FTSE small cap indices. It covers nearly 98% of the UK’s market capitalisation, which can be viewed as a more accurate reflection of the UK economy.
If you wanted to look lower for signs of growth in an economy, you could just look at small cap funds and those listed on the Alternative Investment Market (AIM) which provide deeper exposure to the UK market and are much more sensitive to changes in the local policies and economy.
As for the performance of the indices. Well, energy has had a good run over the last five years and the FTSE100 is up over eight per cent more than the FTSE250. Buried in that is a cliff edge fall of the “covid times”.
Most interestingly, however, is that the smaller UK indices have significantly outperformed the FTSE100 over the last six months, with the FTSE250 showing a 50% uplift on the FTSE100 alone.
- Peter McGahan is chief executive of independent financial adviser Worldwide Financial Planning, which is authorised and regulated by the Financial Conduct Authority. If you have a financial question,call 028 68632692.
