London’s Flagship Index Struggles Amidst Sterling Surge and Plummeting Oil Prices.
London, UK—Despite a booming global stock market in 2023, the United Kingdom finds itself excluded from the rally due to the Bank of England’s aggressive interest rate hikes and a sharp decline in oil prices, which have hindered the FTSE 100, the nation’s premier benchmark index.
The FTSE 100 has significantly lagged behind other prominent developed market indices, managing a meager increase of less than 0.5 percent from its closing level in 2022 by the end of the second quarter. Disappointingly, the index has already fallen by 2 percent this quarter alone. Investors’ hopes for a sustained period of catch-up following the FTSE’s relative resilience last year have been dashed, reinforcing the market’s unpopularity among both domestic and international investors.
Characterized by a strong presence of oil majors and cash-generative value stocks, the UK market struggles to attract buyers due to the lack of large technology firms poised to benefit from the current artificial intelligence craze. Furthermore, the country’s relatively turbulent political landscape and persistently stubborn inflation further deter international investors from venturing into UK equities.
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According to Russ Mould, the investment director at AJ Bell, weak oil prices, escalating interest rates, and uncertainties surrounding the Bank of England’s ability to curb inflation have collectively contributed to the FTSE’s lackluster performance. Mould remarked, “There’s not much tech or AI hoopla to be had.”
In stark contrast, European and US indices have flourished. France’s Cac 40 has surged by an impressive 12 percent this year, largely driven by the success of luxury goods companies, while Germany’s Dax has recorded a remarkable gain of 14 percent. The S&P 500, buoyed by substantial advances in the Big Tech sector, has soared by 14 percent in the United States. Japan’s Topix has reached a 33-year high as investors seek exposure to Chinese growth while minimizing geopolitical risks.
Investors, traditionally attracted by the FTSE’s generous dividend payments, have shifted their attention due to the rising yields on less risky government bonds and the enticing returns offered by money market funds in both the US and the UK. According to Barclays, UK equity-focused funds have experienced outflows equivalent to approximately 6 percent of their total assets since the beginning of the year, while outflows in the US, Japan, and the rest of Europe have been minimal, amounting to less than 1 percent of assets.
The FTSE’s abundance of interest-rate-sensitive housebuilders, banks, insurers, and utility companies has compounded the market’s vulnerability to higher rates. Additionally, the index’s heavy exposure to energy and mining sectors has caused further damage due to plummeting commodity prices, with mining giants Fresnillo, Anglo American, and Glencore among the FTSE’s worst performers this year.
Furthermore, the Bank of England’s struggle to contain inflation has acted as a major headwind. Although rising interest rates caused significant turmoil in global stock markets last year, Europe and the US have managed to recover as inflation recedes from its peak. Conversely, the UK has struggled to rein in prices, resulting in a larger-than-expected rate hike from the Bank of England last week. Market expectations now anticipate UK rates to surpass 6 percent by year-end, exceeding borrowing costs in other developed economies.
Interestingly, the Bank of England’s relatively hawkish stance has boosted the value of the pound, making it the best-performing developed market currency year-to-date. Sterling has also benefited from modest but steady economic growth and regained investor confidence in the wake of former Prime Minister Liz Truss’s brief tenure last year. However, the pound’s strength spells bad news for the FTSE, as approximately 75 percent of its constituent companies generate their revenue overseas. Therefore, when the currency appreciates, their earnings suffer in sterling terms.
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While sterling’s robust performance has enhanced the FTSE’s performance in foreign currency terms, domestic investors have endured some of the lowest returns among developed economies.
Analysts point out that recent chinks in sterling’s armor could offer a glimmer of hope for UK equities. JPMorgan analysts noted that the pound did not broadly outperform following the Bank of England’s surprise 0.5 percentage point rate hike last week, suggesting that the currency’s responsiveness to short-term rate moves is diminishing. Instead, it seems to be increasingly sensitive to concerns of an impending economic downturn and the precarious state of the UK’s ailing housing market. JPMorgan predicts that the pound will underperform, facilitating a potential 9 percent rise in the index to a record high of 8,150 by year-end.
However, not everyone shares this optimistic outlook for the FTSE’s long-term prospects. Barclays analysts, for instance, believe that UK equities, particularly those with domestic exposure, will continue to remain unpopular. They contend that without a straightforward solution to the challenges posed by stagflation and the absence of apparent positive catalysts in the near term, investor neglect of UK equities is likely to persist.
