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Why the FTSE 100 is not the UK’s economic bellwether

Published: 09:38 10 Apr 2019 EDT

FTSE 100 keyboard
The index contains the 100 biggest companies listed on the main board of the LSE, however this doesn’t mean they all have an equal effect on its movement

While it is arguably the most popular indicator for the health of companies on the London Stock Exchange, the FTSE 100 may not be the bellwether for the UK economy that some take it to be.

The index contains the 100 biggest companies listed on the main board of the exchange by market cap, however this doesn’t mean they all have an equal effect on its movement.

FTSE 100 better reflection of global economy?

This is because the FTSE 100 is weighted, i.e. the bigger a company’s market cap, the more likely movements in its share price will shift the needle on the index as a whole.

The FTSE 100’s four biggest companies, Royal Dutch Shell PLC (LON:RDSA, LON:RDSB), HSBC Holdings PLC (LON:HSBA), BP PLC (LON:BP.) and GlaxoSmithKline PLC (LON:GSK) collectively make up nearly 30% of the index’s £1.82trn total market cap, meaning movements in their shares will cause a greater impact than most of its other constituents.

Another characteristic of these large blue-chip firms is their heavily internationalised operations, so what is good for their business may not necessarily be a sign that the UK is doing well domestically.

It also means shares in these firms are more likely to react to macro changes in the global markets than domestic events in the UK.

Global oil prices, for example, recently hit their highest level so far in 2019 at around US$71 a barrel on 8 April. This jump from a 12-month low of US$50.8 last December has been good news for oilers like BP and Shell, who will see better earnings from their sales.

It is a similar story for top-ten FTSE 100 mining firms BHP Group PLC (LON:BHP) and Rio Tinto PLC (LON:RIO), who as some of the world’s biggest iron miners have been boosted by an increase in global iron ore prices, which hit a five-year high in early April.

Earnings play a part too, with strong profits from top FTSE 100 companies pushing up their share prices and taking the index along for the ride.

This can go a long way to explaining why the FTSE 100 managed to finish the first three months of the year 8.1% higher at 7,279 points despite the muddled economic and political picture in the UK.

Could the mid-caps be better?

For a better picture of how the UK’s domestic market is performing, it is often said a better option is the FTSE 250, which incorporates the 250 next biggest companies after the FTSE 100.

Companies in this index include those such as pub chain JD Wetherspoon (LON:JDW) and house builders merchant Travis Perkins PLC (LON:TPK), both of which have heavily UK-focused businesses and are thus more exposed to changes such as consumer spending and construction activity.

With a total market cap of about £350.4bn, the FTSE 250 is worth less than a quarter of its blue-chip big brother. Its weighting is also more balanced with its top ten biggest companies only accounting for around 10% of the total index.

By this metric, the UK economy seems to be in healthy shape, with the FTSE 250 having risen 8.7% in the first quarter to 19,117 points.

However, the FTSE 250’s constituents also derive a large slice of their earnings from international markets.

Laith Khalaf, an equity analyst at Hargreaves Lansdown, said that while the FTSE 250 is “more domestic”, he estimates around 50% of the earnings for companies from the index come from overseas, although this is much less than the 75% figure for FTSE 100 firms.

“[The FTSE 250] is a better barometer of the UK economy but it’s by no means a pure or direct one.”

For example, food maker Tate & Lyle PLC (LON:TATE), the FTSE 250’s sixth biggest constituent, derived over half its sales in its latest half year from North America, Asia, and Latin America, about as far away from the UK as you can get.

So, is there an index that contains companies with much more UK-based earnings? Khalaf says that can only come from looking into the figures for specific companies.

“In that case, you’ll have to roll up your sleeves and pick some specific stocks”.

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