Is the FTSE 100 the most undervalued global stock market, or stale and outdated?
You probably heard that the FTSE 100 was 40 years old last week. The first ever trading day of the UK’s major benchmark was 3rd January 1984. It would be nice to be able to celebrate it, but after a solid first 20 years, the last 20 have been rather disappointing. Maybe life begins again at 40.
Firstly, note that it makes most of its money outside the UK – about 75% in fact, 25% of which is in the US so it is susceptible to currency moves and the global economy, not just the UK economy.
Its composition is ‘old fashioned’ offering something of a history hit (the likes of BP Plc and Shell Plc have been in it since it launched). The main weightings are towards Banks, oil and tobacco, with very little tech.
However, these defensive stocks pay high dividends. This means it generates income, rather than growth (tech) stocks which focus on rising share prices but pay out little in cash.
FTSE dividends hit a record high in 2023 with an estimated yield of 3.9% which is expected to rise to 4.2% in 2024. This is attractive when more volatile high-growth stocks are under pressure (as we would expect this year).
Its 40-year annualised returns lag both those in the US and Europe (5.2% in the UK vs. 9.1% and 7.8%, respectively, says financial company AJ Bell), and it has only just beaten Japan (4.6%). That’s hall-of-shame stuff.
The index has underperformed for most of the current century and there have now been 30 consecutive months of outflows from UK funds, (says investment bank Peel Hunt), something that is endlessly self-reinforcing: The more outflows there are, the worse the market looks and the more unpopular it becomes.
The UK index was doing fine during its infancy and adolescence. In the latter years of the 1980s, it lagged the rest of Europe but beat the US(hard to imagine but it’s true). In the ‘90s, it lagged the US but beat Europe and Japan.
After the dotcom bubble burst, it matched its peers, almost halving between 1st Jan 2000 and 1st Jan 2003 and then rebounding back towards the end of 2007. But that’s where it diverged.
Across the 2010s and the 2020s (up until the end of2023, at least), it was the worst performing index out of that peer group. As a sterling investor, you’d have been better off investing in the US, Japan or Europe.
In 2008, we had the financial crash and it would appear that this sadly broke the back of the financial epicentre that is London.Even though the sub-prime was more of a US issue than a UK issue, as is often the case, the UK still hasn’t really bounced back from that one.
London, of course, is still a global financial capital. These days we can scarcely bring ourselves to admit that in 2007, London was arguably (with New York) the centre of world finance.
So if 2008 was a global financial bubble, it was also a UK bubble, or more specifically, a London bubble.
The problems didn’t begin in 2008 but during the years before as the London hype began. At least a chunk of that apparent statistical prosperity was false.
The financial bubble subsequently burst. If that was the only issue, the UK might not stand out so much. After all, the US was also at the heart of the global finance bubble and Europe went on to have the sovereign debt crisis — which seems to have been forgotten by everyone but me. It has gotten a lot worse, and I predict that this comes back to the forefront of market focus within the next 2 years.
But the collapse in interest rates to zero also had another effect on the UK. The UK’s corporate pension deficits exploded over the period, because the value of their future (theoretical) liabilities soared.
This not only meant that companies had to divert real cash money into increased pension contributions, but the crash also increased the appetite for “safe” assets — ie UK government bonds — to ensure that companies would meet their future obligations to a lot of former employees with defined benefit pensions.
Brexit in 2016 was something of a cherry on the cake. That cratered sterling and sent the UK into a lengthy period of political chaos, one which gave global asset managers all the excuse they needed to put the country in the “too hard” pile.
So what does the FTSE 100 have to look forward to at 40? Is there any hope for a new lease of life? Or is it all even further downhill from here?
Firstly, it’s cheap. No one really seriously denies that. the market is at the bottom of its 30-year range on pretty much any valuation measure you care to mention. But it isn’t just cheap in absolute terms; it’s cheap relative to the rest of the world, and cheap even when you take our old-fashioned sectoral mix into account (a discount of 19%).
It may stay cheap though — perhaps the high dividend payments from the FTSE 100 are a sign that the companies concerned see no growth prospects ahead and nothing else to invest the cash in.
But the right way to look at it is probably to say that it comes with a lower level of long-term capital risk than more expensive markets, that sentiment toward markets and hence the flows into them can turn on a sixpence — look at Japan, which, having been loathed for decades, is now up an annualized 10.6% in local currency terms since 2020.
All of the negative trends mentioned above have either run their course or are past their peak. The most disruptive bit of Brexit is done. Political instability will always exist but the UK is unlikely to be an outlier on that front this year, given all the other elections in the world in 2024.
The post-2008 financial crisis is well and truly over and with interest rates now back above zero, the big pension fund switch from equities to gilts may not reverse but it’s gone as far as it can.
If another big tech bubble is forming, the UK should avoid it as we don’t have any big tech in the index. And on the upside, if companies are able to offload their pension schemes onto insurers or at least cut contributions, that means more money to invest or to return to shareholders.
UK equities have been uniquely weak for reasons that extend beyond the composition of the index. But those trends have largely run their course. So now it’s mostly sentiment at work. And sentiment can turn quite quickly — particularly if a panicked government decides to introduce tax breaks into the mix.
If the FTSE 100 remains some sort of global bargain bin then be patient.
The best-case scenario is that funds around the world look for high-dividend stocks that are cheap to add to their global portfolios at a time when defensive stocks are needed. It might take time, or it might happen quite quickly; the problem, as is always the case when dealing in the markets, is nobody knows when until it’s happened.
Once it has happened, of course, everyone can come out and say they knew it would!
The FTSE 100 had a weak late 20s and a nasty 30s — but having hit rock bottom relative to its peers, its 40s might prove to be some of its best years.
