FTSE 100: a closer look

by George Hatjoullis

There is a growing trend towards passive investing. This normally takes the form of tracking some in index. It often goes unremarked that an index is simply a portfolio of stocks weighted in some way (usually by market capitalisation). For the small investor this is a practical way to gain wide exposure to an equity market at low cost. However, the investor should still not lose sight of what they are buying and indeed if the index represents the economy in which they wish to invest. Consider the FTSE 100 index of the 100 largest UK listed stocks.

Although the UK economy has performed relatively well in the last few years the FTSE 100 has been a relatively poor performer. This is partly because the FTSE 100 does not represent the UK economy. The constituent companies in this market capitalisation index are by and large global in that they earn a substantial proportion of their revenue from overseas activity. It is an index that is very sensitive to the global economy. It also has a relatively high weight in oil and gas (10.18%) and basic resources (3.5%) which have had a torrid time of late. The dominant groups however are financial with banks (10.59%), insurance (6.2%) and financial services (6.74%). The largest company by market capitalisation is a bank, HSBC, which is very much a global group. For the ethical investor one should also note that tobacco, alcohol and arms are also well represented.

One of the most noticeable and attractive features of the FTSE 100 is the high yield. At close of business on January 25, 2016 this weighted average yield was 4.27%. This is a historical yield based on the current share price and declared dividends in the last 12 months. In a world in which 10 year gilts offer less than 2% this is very high. Of course the gilt coupon will be paid whilst dividends are less certain. Nine of the constituents have already cut their declared dividend in the last 12 months. The high yields on offer suggest more may follow. The experts may be able to select those companies that will hold or grow their dividends. They will offer their services via managed income funds, but at a price. It is not necessarily a price worth paying. At 4.27% a low cost tracker leaves quite a bit of room for a dividend cut that might still leave a better net income after fees. For the income seeker with limited capital, the FTSE 100 may not be a bad choice.

The timing, however, may not good. The dividend yield could go higher as share prices continue to fall. The global equity markets are in tizz with talk of crisis and meltdown. The big problem is China and the over investment inspired by this economy in the last 10 years. Supply of energy and commodities now exceeds demand by some margin and prices have fallen, and may still be falling. Companies that have over invested through debt may have trouble servicing this debt generating losses for those that have loaned. Banks such HSBC, which have a big China connection, are particularly affected. It is not hard to see why the FTSE 100 is having a tough time and may yet go lower. However, everything has a floor and it is as well to get some context.

FTSE 100 Monthly

The above is a monthly chart of the FTSE 100 going back to 1997. It is a huge range. The first collapse that ended in 2003 was the outcome of the Dotcom bubble. The second big collapse was the outcome of the 2008 banking crisis. There is of course an upward bias over the period as can be seen from the 21 month moving average (the black line). The question that investors now need to answer is; is this a comparable event to the Dotcom and banking crisis. My own view, elaborated in recent blogs, is that it is not. I could of course be wrong. The consensus mood suggests that I am indeed wrong and that over the course of the year the FTSE 100 will bottom closer to 4000.

The chart includes a rough drawing of a much loved technical tool, the Fibonacci retracement lines.  These suggest we could have already seen the bottom but it is also possible that 5326 may prove to be the final bottom. It is interesting to note that so far this month the FTSE 100 has held at the 200 month moving average. I am inclined to think that there is further weakness to come. However, I am less concerned about the price level than the lower chart, the RSI. It is best not to consider buying until the black line has turned decisively up or at least has fallen below the red line. So I keep watching the chart and listening to the mood music being played by the market. At the moment it is a dirge.