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Market View

As the UK economy slows, is it time to fall in love with the FTSE 100 again?

A PDF version of Market View is available.

Over the years, the FTSE 100 has become increasingly unloved. It’s now rarely used as a benchmark for funds and, for the last two decades, has been largely outperformed by the FTSE 250. It’s widely regarded as a stock market stalwart – experienced and a solid performer, but lacking in a little excitement.

The UK has enjoyed over 20 years of strong economic growth, with smaller UK-centric firms performing well, and generally better than the mega-cap multinationals. Consequently it’s not surprising that the FTSE 100 fell out of favour since it holds a high proportion of these global earners. Investors struggle to remember a time when large and established UK companies outperformed their smaller, faster-growing counterparts, hence the reason the FTSE 250 (a proxy for smaller, more domestically focussed businesses) became the UK index of choice. But could that be about to change?

Challenges facing the UK economy

It’s clear that the UK economy is facing several challenges in the medium to long term, and typically the FTSE 100 comes into its own when the UK’s economy is underperforming the rest of the world. Why? Because many of the companies within the index are global, and have operations in overseas markets.

So what are the challenges facing the UK?

Government spending is unlikely to increase

July’s report from The Office for National Statistics (ONS) saw the UK’s first budget surplus since 2002, meaning the country spent less than it received for the first time in 15 years. And this trend looks set to continue. As the graph below shows, UK borrowing is at its lowest level since 2009, and is projected to decrease further over the next five years. Clearly, the Government is hoping that economic growth will come from elsewhere.

Source: Office for Budget Responsibility

“While UK economic growth looks set to hover between the 1% and 2% mark in the medium term, global economic growth continues to strengthen. In this environment, where optimism is the consensus view, it becomes even more important to remain disciplined with regards to the prices we pay for investments.” - Philip Smeaton, Chief Investment Officer

Corporate spending has also decreased

In addition to the Government tightening its belt, there are signs that private sector investment has also fallen. If this pattern continues, we’re unlikely to see any meaningful economic growth in the corporate sector – unless there’s an influx of foreign investment, which is unlikely given that Brexit is casting a shadow of uncertainty over all but the most obvious investments.

Can the consumer save the day?

In many ways, the consumer has been something of a cushion for the UK since Brexit. They’ve continued spending and going on holiday… but for how long? With real wages falling, savings rates already at rock bottom levels and consumer credit growing year-on-year (see graph below), they are running out of tools to keep the economy buoyant.

Note: Net lending to UK individuals (excluding student loans), not seasonally adjusted.
Source: Office for Budget Responsibility

Unfortunately, the outlook for the UK economy remains subdued beyond the immediate future. We must be extremely selective of the kinds of UK businesses we own. If the rest of the world were to slow down (which is not something we expect), the chances of a recession here would be high.

“We recently took the decision to tilt our UK exposure towards firms that have a focus in foreign markets, and away from businesses that are purely UK-based. This naturally draws us to FTSE 100 companies, as they better represent what we’re trying to achieve.” - Matthew Brittain, Investment Analyst

The global view

Global growth appears broad-based, and set to remain strong in the third quarter of this year. We’re still concerned about the fact that asset prices are being driven even higher. This is increasing the level of risk for investors, as a negative economic surprise would lead to a larger fall in asset prices.

The markets have generally lost interest in President Donald Trump and have returned their attention to central bank policy. We expect the US Federal Reserve to begin letting its balance sheet unwind in the background while it continues to raise interest rates in a steady and predictable fashion. The European Central Bank is moving towards a less accommodative monetary stance, and we expect it to taper its quantitative easing when the current programme ends, eventually moving interest rates higher in about 12 months’ time.

Global headline inflation rates are likely to remain stable around the 2% mark, as oil prices have traded in a fairly narrow range over the last 12 months.

A PDF version of Market View is available.

This article is for information purposes and should not be treated as a forecast, research or advice to buy or sell any particular investment or to adopt any investment strategy. Any views expressed above are based on information received from a variety of sources which we believe to be reliable, but are not guaranteed as to accuracy or completeness by Sanlam Private Wealth. Any expressions of opinion are subject to change without notice. Reproduction of this commentary is not allowed in whole or in part without prior written agreement from ‘Sanlam Private Wealth. Past performance is not a reliable indicator of future results. Investing involves risk. The value of investments, and the income from them, may fall as well as rise.

Investing involves risk and the value of investments and the income from them may fall as well as rise and are not guaranteed. Investors may not get back the original amount invested.