Outlook for the FTSE 100

by George Hatjoullis

The FTSE 100 is a curious equity index. It is widely regarded as the pulse of the UK equity market yet actually represents the global, rather than the UK, economy. It is influenced by sterling largely because so many big capitalisation components generate non-sterling revenues. The strong performance since June 2016 in FTSE 100 has not been unrelated to the Brexit inspired collapse in sterling. Interestingly, according to Quant Insight , the investments analysis group, the sensitivity of the FTSE to sterling is now very small. In the language of the Quant Insight analytics sterling is no longer a ‘driver’ of the FTSE. The QI analytics identify oil prices and credit spreads as the main drivers of the FTSE. Higher oil prices help the index whilst wider credit spreads hurt the index. The analytics also suggest FTSE is about 140 points overvalued given the level of the ‘drivers’. In other words, FTSE could come off a bit even if oil prices and credit spreads do not move very much.

The value of this analysis is in identifying a few variables that ‘explain’ FTSE movements at the moment. One still needs a view on these other variables and sensitivities can change. The QI analytic offers no explanation as to what changing sensitivities might mean. In the case of sterling it may be that the equity market recognises that sterling has made a ‘step’ adjustment to reflect the loss of competitiveness of the UK economy on leaving the EU, and that further ‘step’ adjustments are unlikely. Sterling has moved to a new, lower, trading range but will not decline further on a trend basis. Hard brexit has been discounted.

The oil price sensitivity reflects, in part, the high weight of oil and natural resource stocks in the FTSE. The continued sensitivity would suggest that the equity market fears further material moves in the oil price. If this fear diminishes and the current trading range comes to be normalised it may be that this factor sensitivity will also diminish. Credit spreads however are always active and other factors may become significant. QI analytics serve to remind us that what drives equity prices is a moving feast.

ftse-100

The QI overvaluation signal for FTSE is consistent with technical analysis. The index looks overbought so a correction is highly likely. However, the long term trend may still be higher. The 21 day moving average is 7184 which is about 140 points lower. Moreover, FTSE 100 has made a new high and has decisively moved away from the peaks seen during the hugely volatile but sideways period of 1997 to 2016. This is encouraging. It is also superficially counter-intuitive given the dark political setting faced by the UK. One needs to recall that the FTSE 100 is an index of global companies with a high weight in resource stocks and financials. It has lagged as these sectors have lagged and it may do relatively well as these sectors outperform. Things change.

 

 

 

Advertisements