Wednesday, 24th April 2019
The FTSE Index I want to see….
How is the UK economy doing right now?
It’s a good question….
And for most people I know, the two-second version of the answer lies in the performance of the stock market – with the emphasis on one specific index….
‘The FTSE 100 is up 11%+ since Christmas, Dave. If the UK were doing any better, I’d be sending out for champagne and cigars….’
- So simple….
Perhaps it really is as simple as that….
Perhaps the closing figure of the FTSE 100 really does contain all the information we need to gauge the current health and outlook of the UK economy….
The headline writers would like you to think so….
The FTSE 100 is the UK media’s go-to Index – the barometer of choice….
Its movements are tracked and reported daily by most newspapers and mainstream news programmes on TV….
As a result of that rigid and unrelenting focus, the FTSE 100 is the market reference point most of us are familiar with….
For most people, I suspect the FTSE 100 is the stock market. The entire market….
For most people, when the FTSE 100 is up, the UK is going well….
- But here’s the problem….
Trouble is, the FTSE 100 is NOT what it seems….
The FTSE 100 is NOT what it is widely purported to be….
The FTSE 100 is NOT a particularly reliable gauge of UK economic health. Here’s why….
The FTSE 100 Index consists of the 100 biggest companies listed on the UK stock exchange as measured by market capitalization….
These big ‘blue chip’ firms are not necessarily or primarily UK-focused….
Their operations are heavily internationalized – meaning that they make plenty of their revenues in countries other than the UK….
It does not follow that the things which benefit these internationally-oriented companies are also a benefit to the UK’s economic health….
Quite the opposite. Because the FTSE 100 companies are so internationally-focused, they can benefit from global macro-trends that damage the UK’s domestic economy….
In other words, the FTSE 100 companies could be going well while the UK economy slides down the pan….
And we should also keep it in our minds that the FTSE 100 is a weighted index….
What that means in practice is that the bigger the market capitalization of a FTSE 100 company, the more influential its price movements are in shifting the index performance as a whole….
The price movements of really huge companies like Royal Dutch Shell, HSBC Holdings, BP, GlaxoSmithKline and British American Tobacco – all with market caps amounting to tens and hundreds of billions of pounds – will have a much bigger impact on the performance of the FTSE 100 as a whole than other FTSE 100 companies….
Does it seem logical to you that the performance of a few big blue-chip stocks should be seen as a gauge as to the state of the country’s economic health?
No, me neither. Reliance on such a gauge can only lead to a totally skewed view of reality….
- Moving on to the FTSE 250….
So, if the FTSE 100 is out as a reliable guide to the health of the UK economy, what about the FTSE 250?
The FTSE 250 consists of the 250 companies that are the biggest after those that are on the FTSE 100….
With a total market capitalization of approximately £350 billion, the FTSE 250 is worth roughly about 25% of the ‘blue-chip’ FTSE 100 index….
But no matter. Because many of the companies listed on the FTSE 250 are recognized as British-based brands – for example, William Hill, Stagecoach Group, Royal Mail, JD Sports and Wetherspoons – the FTSE 250 index is accepted in some quarters as a more reliable indicator of the UK’s overall economic health….
And with that index up 14% since Christmas, perhaps the UK economy is doing well right now….
But, dig a little deeper and you soon run into a familiar problem….
FTSE 250 companies might do a lot of their business in the UK. But they are also active in foreign markets and earn a good proportion of their revenues overseas….
I recently saw some estimates attributed to an equity analyst at Hargreaves Lansdown….
What he said amounted to this: FTSE 100 firms get about 75% of their revenue overseas compared to 50% for FTSE 250 companies….
In other words, the FTSE 250 companies are not as internationally-oriented in their revenue-generating operations as the big beasts on the FTSE 100 but, with 50% of their revenues sourced outside the UK, they cannot be considered a clean and direct guide to UK economic health either….
- What I would like to see….
What I would like to see is a specific FTSE index that contains a hierarchy of UK companies that make no more than (say) 20% of their revenues in overseas markets….
I think that would be an interesting index – one that would filter out the noise of earnings from foreign markets and focus on UK businesses operating ostensibly in UK market conditions….
Such an index would surely offer a more accurate snapshot of how the UK economy is doing at any given point in time….
I don’t know if this is possible – though I suspect it is. And I don’t know what body would produce this index ( I will be sending an email to the Stock Exchange later today in a bid to find out)….
But until such an index is produced (and it may never be), those of us who wish to take a view on the UK’s economic health – via the filter that is the market – are stuck with faulty gauges….
Neither the FTSE 100 nor the FTSE 250 are fit for purpose….
That’s the truth of it as we see it….
All the best,