Why has the FTSE 100 Index performed so well while the UK economy falters in a recession?

2023-04-03 05:28:28 ET

2022 was a hell of a year for stock market investors.

Risky assets had their worst year since the great financial crash of 2008, as inflation rose aggressively, forcing central banks into the fastest cycle of interest rate hikes in recent memory.

And while 2023 has brought some lull as the market moves towards expectations that interest rates may fall sooner than expected, investors are still licking their wounds from the magnitude of last year’s pullback.

But not everything was looted. Amidst the madness, there were havens for investors. One of them was the FTSE 100 index.

The UK index is within 4.6% of its all-time high, hit in February this year.

The presentation of its performance in 2022 compared to a selection of other equity indices underscores the magnitude of its outperformance.

It was the only index to produce a positive return for investors as pretty much every other major stock index fell massively, both in terms of tightening monetary policy and the Russian war in Ukraine, as well as ongoing COVID effects (particularly in China ). ).

Why has the FTSE hit an all-time high?

So how did the FTSE 100 index hit an all-time high this February?

It certainly cannot be due to the performance of the British economy. In February, the IMF forecast that Britain would be the only advanced economy to shrink in 2023.

The country struggled economically after Brexit. I wrote an in-depth look at the nation’s plight last October but it has been a very tough road for the UK.

Perhaps 2022 can be summed up with the disastrous 49-day reign of Prime Minister Lizz Truss, who was forced to leave after an unfortunate budget nearly bankrupted the country. The Bank of England eventually stepped in as buyer of last resort to stem a full-blown pension crisis.

And so, in seven weeks, the UK has had three prime ministers and two monarchs, all while grappling with a massive cost-of-living crisis – even today, inflation remains at 10.4%, up 30 basis points from last month.

In short, no, the UK economy is definitely not doing well.

Energy crisis and commodity prices fuel FTSE 100 gains

While the energy crisis caused major problems for the economy as a whole, the boon to oil and energy prices drove stock prices higher – contributing to the FTSE 100’s strong return.

Oil firms including BP and Shell reported record profits as investors’ pockets were fuller than ever despite the bleak backdrop behind soaring oil prices.

The index was also boosted by commodities, prices of which have risen sharply due to supply constraints and China’s transition from zero-COVID to a full reopening.

As profits mushroomed on the back of these factors, share prices have soared, counterintuitively when compared to the sluggish UK economy.

The FTSE 100 also lacks technology companies. It can almost be considered a boomer of indices, with fewer Silicon Valley guys and more old-school companies like oil, mining, tobacco and banks.

And there hasn’t been a worse sector over the past year than technology, given its particular sensitivity to rising interest rates.

Weak pound and multinational gains

Then there is the question of where the profits come from. Around 75% of FTSE 100 companies’ revenue comes from abroad.

Not only does this mean that companies’ prospects are less tied to the fate of the UK, but they have also received a massive boon from the pound’s sharp depreciation against the euro ( USD/GBP ).

While recovering somewhat since October, the pound has been crushed by its US counterpart for most of 2022.

In summary, the composition of the FTSE 100 is quite unique as it is more sensitive to commodity prices and overseas earnings, meaning 2022 was a perfect storm for it as commodity prices soared and the pound depreciated.

The best way to illustrate this is to compare the performance of the FTSE 100 to the FTSE 250, the UK’s other index, but composed of the 250 largest companies by market capitalization rather than the 100 largest companies.

The difference in performance between the two indices was the widest since the 1980s, with the FTSE 250 becoming more sensitive to the British company, falling 19.7% compared to the FTSE 100’s 4.7% gain.

It was the first time the FTSE 100 had outperformed the FTSE 250 since 2018.

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