It’s been a recurring question for UK investors over the last two decades: is the FTSE 100 fit for purpose? The question has taken on new significance in the last two years, as the FTSE 100 has been one of the few major global indices not to reach a new record high.
There was progress in February 2015 when the index finally surpassed its previous record high of 6,930 set in December 1999 to close at 6,950. Since 2015 growth has been sporadic, with the most recent record set on 22 May 2018 when the index reached an intraday high of 7,903.50 before closing at 7,877.45.
In the last three years, the closest the index has come to that 2018 peak was in January 2020 when it hit 7,689 during intraday trading. Then came the cliff edge brought on by the pandemic, with the index collapsing to 4,899 on 16 March 2020, as coronavirus spread around the world and governments pressed pause on the global economy.
The FTSE 100 quickly recovered, climbing to 6,500 by June 2020, before slipping back towards 5,500 in October. The index has spent the last 12 months clawing its way back to its current level above 7,000, but remains well short of the 2018 peak.
Contrast the FTSE 100’s performance to that of other global benchmarks – or even the FTSE 250, which has set new record highs on a regular basis – and it’s a dismal performance.
Why has the FTSE 100 underperformed?
Although there are mitigating factors, to be discussed below, the question persists as to why the UK clings to an index that diverges so much from other major global indices.
FTSE 100 underperformance chart since 2019
Source: CMC Markets
As the chart above shows, the FTSE 100 has only just returned to levels last seen at the beginning of 2019, while peers such as the German DAX and Japanese Nikkei 225 have motored ahead, with the US’s S&P 500 going almost parabolic.
Some commentators pin the blame for the FTSE 100’s underperformance on Brexit, but this fails to explain why the FTSE 250 hasn’t been affected in a similar way. The reality is that the FTSE 100 has underperformed for years, partly because of its composition.
Since its inception in 1984, the FTSE 100 has evolved from an index of UK-focused businesses to one that reflects the fortunes of the world economy. UK-oriented companies have been replaced by multinationals. Although almost all of the FTSE 100’s constituent companies are UK-domiciled, only about a third of their revenue comes from the UK. Meanwhile, companies listed on the FTSE 250 generate more than half of their revenue in the UK. It could be argued that the FTSE 100 no longer paints an accurate picture of the UK’s corporate landscape.
Another argument is that the FTSE 100 hasn’t necessarily underperformed, so much as rival indexes have benefited from their own unique circumstances. This brings us to an important point – when we look at different markets, we should understand that we aren’t always comparing like with like.
Starting with the S&P 500, a huge number of US companies have bought back their own shares following various tax changes introduced by the Trump administration, boosting their valuations. This has been a consistent theme in the US since 2016.
Meanwhile, the Nikkei 225 has continued to be buoyed by large-scale ETF buying by the Bank of Japan, helping boost the index to its highest levels in over 30 years. And, with a recently elected Japanese government set to implement a new fiscal stimulus plan, we could see the Nikkei 225 move and hold above the 30,000 level for the first time since 1990.
Finally, the DAX is a total return index, which includes dividend reinvestment. If the FTSE 100 were a total return index, it would likely also be posting record highs, or at least be above its current level.
In light of all this, it is perhaps unsurprising that the FTSE 100 has performed less well than some of its peers. This relative underperformance has continued through 2021, with the index briefly edging towards the 7,400 level before falling back to just above 7,000 in late November on concerns over a new Covid variant.
Challenging times ahead
With vaccines and booster shots keeping the global economy ticking over, we’re now starting to see some of the side effects of the global shutdown from 2020.
It turns out that when you switch everything off at once it’s not easy to switch it all back on again, especially after governments around the world offered their citizens financial support to encourage them to stay at home and observe Covid-19 restrictions.
We now have a situation where demand for goods is outstripping supply. At the same time, governments are seeking to transition to a new, more sustainable economic model. This may not prove as straightforward as some in the green lobby would have us believe, and it is not without costs.
We won’t be able to transition to renewables at the flick of a switch, especially given the complexity of global supply chains, which rely heavily on fossil fuels for “just in time” delivery.
The big question now is what happens next, and that’s a hard question to answer, given the complexities outlined above. However, the near-term outlook remains positive for markets, despite frothiness in some quarters, particularly in US markets.
UK 100 - Cash Market performance chart (2021)
Source: CMC Markets
The S&P led the way in 2021
Once again the S&P 500 has outperformed its peers this year, hitting new record highs almost every month, while the Nikkei has underperformed despite hitting 30-year highs in September.
The response of the US Federal Reserve continued to aid the rally in US markets, though its monetary policy interventions are now being withdrawn. During the pandemic, the central bank rolled out various lending programmes and bought so-called “fallen angels” – bonds that had an investment-grade rating but have been reduced to junk bond status because of their issuers’ financial difficulties. These purchases of corporate debt acted as a kind of put against the bankruptcy of several large US companies.
Meanwhile, the FTSE 100 continues to be held back by a few significant underperformers. The sectors hit the hardest by the pandemic – travel, leisure, general retail, energy, and banks – make up a significant proportion of the FTSE 100. Little wonder, then, that the FTSE 100 has continued to lag.
In 2020 airline group IAG finished the year down more than 60%, while Rolls-Royce, BP, Royal Dutch Shell, and Lloyds Banking Group closed the year more than 40% lower. NatWest Group ended the year down more than 30%. Although the banks and oil companies have rebounded this year, IAG and Holiday Inn-owner InterContinental Hotels are down for the second consecutive year, while big cap names like Rio Tinto, Tesco, Unilever, and Reckitt Benckiser have also struggled, partly due to concerns over rising costs.
Similarly, shares in UK housebuilders remain below their pre-pandemic peaks, despite solid results this year and strong order books, perhaps because of concerns that a Bank of England interest rate rise could dampen demand for housing. The predominantly London-based Berkeley Group is the worst performer, with Taylor Wimpey not far behind.
Looking ahead to 2022, things could improve for the travel sector if new Covid variants can be tamed. Despite their poor performance this year, IAG and InterContinental Hotels could benefit from the reopening of transatlantic routes from November, offering grounds for optimism going into the new year.
FTSE 100 could be set to make gains in 2022
Provided that the current inflation storm blows over, there is no reason why the FTSE 100 cannot move beyond its 2021 high of roughly 7,400 and edge towards the record high of approximately 7,900 that we saw in 2018, and possibly even break through the 8,000 barrier by the end of 2022.
Besides inflation, other challenges facing the UK economy include rising energy prices and the tax increases that were foreshadowed in the autumn budget, though some of these hikes may be deferred if coronavirus restrictions are reintroduced.
Elsewhere, the rebound in European markets this year has been impressive, as gains were achieved despite concerns over fiscal interventions and the sustainability of European growth. While the pandemic has hit the likes of Spain and Italy the hardest, we have seen some semblance of a decent recovery in those countries, though the rebound was hampered by their large tourism sectors, which are operating at a fraction of their pre-pandemic capacity due to lockdowns and travel restrictions.
Looking ahead, dissatisfaction with the EU remains a danger for politicians across Europe, as highlighted by the shambolic rollout of the vaccine programme. So far, the president of the European Central Bank (ECB), Christine Lagarde, has been able to hold the governing council together. However, the resignation of Jens Weidmann as Bundesbank president exposes simmering tensions in German monetary circles over current policy. The ECB’s pandemic emergency purchase programme (PEPP) is due to expire in March 2022, though its asset purchase programme (APP) is expected to continue.
Meanwhile, the US economy was buoyed by the rollout of a third fiscal stimulus programme at the beginning of 2021. Measures included payments of $1,400 to most Americans, a $300-a-week unemployment insurance boost until 6 September, and $350bn for state, local and tribal relief. These measures also boosted US company earnings, which benefited from the extra spending power that the payments gave to consumers. With an infrastructure bill signed off in November, we could see a further uplift for US markets in 2022, if inflation can be contained.
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