The UK will be the only G7 country to see its economy shrink this year, the International Monetary Fund predicted this week.
The stock market, on the other hand, is doing just fine. Almost five years after its last closing high, the FTSE 100 index hit a new one on Friday.
Can nonexistent growth and rising share prices make sense? Actually, yes. The main factors driving the index to 7901.80 are all explicable.
First, remember what’s being measured. A stock market index is not a symbol of national economic virility, which is especially true for the FTSE. This collection of the 100 largest qualifying companies listed in London could hardly be more international – try a Chilean copper miner (Antofagasta) or producers of silver and gold in Mexico (Fresnillo).
Even distinctly British names at the top of the size-weighted index are best thought of as multinationals. Shell, the biggest of the lot, makes less than 5% of its revenues in the UK. AstraZeneca, in second slot and a UK national champion in pharmaceuticals (with joint Swedish parentage), generates more of its sales in the US. In aggregate, about 75% of FTSE 100 firms’ revenues come from outside the UK.
Second, stock markets anticipate events. The possible new development being priced up is that the global inflation shock will not be as severe as feared, the downturn will be shorter than previously expected and central banks will not push interest rates as high as they have threatened. None of these things is guaranteed to happen, but markets tend not to wait for proof.
“Stock markets always move faster than the economy,” says Tom Stevenson, investment director at fund manager Fidelity International. “They look through the headlines and often move quicker than you expect.” The biggest contributor to the re-think is probably the fall in energy prices with the warm European winter.
Third, the Chinese economy has reopened. The whoosh can be seen more directly in markets such as export-heavy Germany, where the Dax index is up 10% since the new year. But the FTSE crew of commodity stocks should also benefit if Chinese demand for raw materials accelerates. Top-10 heavyweight Rio Tinto, when it isn’t hunting for missing radioactive capsules, ships vast quantities of iron ore from the Australian desert to China’s steel mills. Its shares have soared by a third in three months.
Fourth, the FTSE 100 looks cheap versus other indices. As a whole, the companies are valued at just over 10 times their expected earnings over the next 12 months, which compares with 17 times for the S&P 500, the most broadly based US index. “It is one of the cheapest indices globally, and unlike the US market, toward the bottom of its historical [price-to-earnings] range,” Goldman Sachs strategists said in a recent note.
The flipside of relative cheapness is that the FTSE has been a shocking performer in international terms for ages. On New Year’s Eve 1999, the index closed at a then-record 6,930 at the height of the dot-com bubble. An improvement of 14% over 20-plus years to today’s level is nothing to shout about.
In practice, your investment outcome would have been substantially better if you had reinvested dividends along the way, but it is also true that the S&P 500 peaked in 2021 at three times the level of its dot-com high. Fidelity International’s Stevenson views the UK index as “very attractive”, but says “that is reflective of the long-term underperformance – it has been very out of favour”.
Fifth, a related point: London’s lack of technology stocks has suddenly become a short-term relative advantage. Tumbling stock prices of the likes of Amazon, Meta and Tesla through most of 2021 have whacked US indices, but the UK’s crew of dividend-paying Jurassic plodders (as the caricature has it) are enjoying a moment in the sun. A 4%-ish yield on the index ain’t bad if interest rates aren’t going as high as previously thought.
Sixth, a corporate earnings calamity has not materialised. For the 25% of FTSE earnings that come from UK, the news flow has not yet matched the gloomy mood. Domestic banks stress how little bad debt they see on their loan books. Big quoted-company retailers – the likes of JD Sports, Next, Sainsbury’s and Tesco – have sounded positive.
None of which deflects from the problems facing the UK economy. Goldman Sachs strategists offered a long list: lack of energy independence, a tight labour market, the drag of Brexit on trade. But the title of their analysis was instructive: “Bad economics; good value”. Yes, both are possible at the same time. The market could still plunge next week, naturally, but this week’s long-awaited record high feels rational.