After nearly five years of waiting and a string of major global events, including pandemic, war and possible recession, the UK’s top index has briefly traded higher than ever before.
The FTSE 100 has just hit an all-time high at 7,906.58, exceeding the previous best of 7,903.5 achieved on 22 May 2018. The moment was brief but significant, and particularly good news for investors in the UK’s blue-chip index.
It comes at a time when the UK economy is far from being in good shape. High inflation, rising interest rates, falling real wages and a cost-of-living crisis for many are real headwinds. At the same time, the country is hostage to any number of strike actions which have inevitably impacted productivity.
The recent success of the FTSE 100 is, therefore, something of a conundrum at first glance.
However, a number of factors explain the apparent contradiction.
Perhaps most importantly, the index is not an accurate barometer of the UK economy. An estimated 75% of company earnings come from overseas which, coupled with the more recent weakness in sterling, means that these earnings become more valuable on repatriation.
Today’s surge was in part triggered by strong US jobs data, which showed the American economy added 517,000 jobs in January, far more than expected. That sent the dollar soaring against the pound.
The composition of the index also helps to explain the outperformance. The proliferation of mining stocks such as Glencore (LSE:GLEN) and Rio Tinto Registered Shares (LSE:RIO), and oil majors BP (LSE:BP.) and Shell (LSE:SHEL) saw a strong benefit from soaring energy prices last year. There is also a large contingent of financial stocks, including big banks such as Lloyds Banking Group (LSE:LLOY), NatWest Group (LSE:NWG) and Barclays (LSE:BARC, which are generally boosted by rising interest rates as the “positive jaws” (the difference between the rates at which banks lend and borrow) widen.
At the same time, there are a number of defensive stocks with pricing power, which mitigates the effects of inflation as these companies have the ability to pass on price increases without sacrificing market share, such as the likes of Diageo (LSE:DGE), Unilever (LSE:ULVR) and Reckitt Benckiser Group (LSE:RKT).
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Another reason for the more recent appeal of the FTSE 100 is the relatively high level of dividends. The average yield of the index is currently 3.5%, nearer to its longer-term level after the ravages of the pandemic dissipate (many companies chose to reduce or remove dividends given the economic impact of Covid-19).
Over a period of time, this has a significant effect on returns. Since New Year’s Eve 1999, the index has added just 14% on a simple returns basis, which often erroneously elicits the quote that the FTSE 100 has delivered very little for investors over two decades.
This overlooks two vital factors. First, the index is reshuffled on a quarterly basis, with usually two or three stocks being relegated to the FTSE 250. The FTSE 100 of today, therefore, bears little resemblance to the index at the turn of the century.
Second, the simple share price return ignores the power of compound interest. Over the same period, the total return (which includes dividends reinvested) is 159%.
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These combined factors resulted in a strong outperformance compared to many other global indices last year. In 2022, for example, the main indices in the US plummeted - the Dow Jones was down by 8.8%, the S&P500 by 19.5% and the technology-heavy Nasdaq by 33.1%. The FTSE 100 eked out a gain of 0.9% (excluding dividends).
It is the FTSE 250 which is generally accepted to be a more accurate barometer of the UK economy’s performance and prospects. A decline of 20% in 2022 reflected those difficulties on home soil, although a rebound under way since mid-October has seen the mid-cap index trade at an eight-month high.
The strength of the FTSE 100 is therefore positive news for its constituents, which happened to be based in the UK, as opposed to the performance of the UK economy itself.
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