FTSE 100 vs Nasdaq: what next for the UK index
The end of Q3 is upon us, and it was a rough one for stock market bulls. The S&P 500 eked out a mere 0.2%, dragged lower by a particularly bad September. More than half of the companies in the S&P 500 fell in Q3, including some of the big hitters such as Facebook and Amazon. While this was a rough quarter for most global stock indices, the performance of US indices over this quarter tells us something important. In September we saw growth sensitive stocks and small caps outperform the tech titans. This could all be good news for the FTSE 100, which is small (compared to the US giants) and full of cyclical, growth-sensitive stocks.
UK: the harsh end of a stagflation reality
It’s been a big week for the UK, stagflation concerns have manifested themselves in queues across petrol forecourts around the UK for gas that is in short supply due to a logistics rather than refining problem – we don’t have enough truck drivers here in the UK. Q3 growth surprised on the upside, bond yields surged, the 10-year Gilt yield has jumped from 0.52% a month ago to 0.93% today and sterling has plunged as stagflation fears have gripped market sentiment. GBP/USD is at its lowest level since December 2020, and after easily sliding through $1.35 support, the next major support level for this pair is $1.3220, the 38.2% retracement of the March 2020 low to the May 2021 high. Rising inflation and slowing growth is like kryptonite for most risky assets. While other markets are selling off sharply, we think that there are some reasons to be hopeful that the FTSE 100 can weather the storm.
Below we look at four factors that could help to boost the FTSE 100’s attractiveness, especially vs. the tech heavy Nasdaq in the coming weeks and months.
1, Rising interest rates. This is bad news for tech stocks, as interest rates based on benchmark US Treasury yields are usually used for discounting future cash flows. As yields rise, future cash flows fall. The question now is, will yields continue to rise? There has been a monumental increase in Treasury yields this week, with the 10-year yield now above 1.5% compared with 1.29% a month ago. The 2-year yield is now 0.28%, suggesting a full interest rate rise is now priced in for 2022. For now, with tech stocks falling, traders are looking at other “safe” asset classes to buy. Sectors that tend to perform well in a stagflation environment include energy stocks, which were the only harbour in the storm for the S&P 500 last quarter. Luckily, energy makes up more than 20% of the FTSE 100, and it could act as a hedge against a stagflation environment. BP, the UK oil major, has seen its fortunes rise this week, with the stock rising to its highest level since June 2020 on Thursday. We believe that there is further upside for energy companies like BP in the coming weeks.
2, The Tina effect: there is no alternative to the FTSE 100 right now. This is one of the acronyms doing the rounds at the moment, and it feeds in nicely to our view that the FTSE 100’s star is rising now that the limelight is starting to fade on last year’s top performing tech titans. Investors are dismissing tech stocks because of rising rates, but they need something else to buy. There is probably further upside for yields to go, so now may not be a good time to buy sovereign bonds (yields move inversely to price). This leaves the FTSE 100 as the asset of last resort. It’s not a particularly impressive reason to buy an index, however, it could be smart in this stagflation environment.
3, Sterling: As we mention above, the outlook for sterling is fairly bleak right now. It’s taken a beating against a resurgent dollar in Q3, and from a technical perspective the next major support level for GBP/USD is $1.3220. Some may argue that I am being too pessimistic, however, GBP has got a history of volatile moves, which is why it is often compared to an emerging market currency. We have seen huge moves in sterling before, also the vote for Brexit appears to have permanently reduced buying interest for the pound, and it has never recovered its June 2016 high. The fact that the negative impact of Brexit, and a gross lack of planning for its consequences by the UK government, is now coming home to roost, is another reason to ditch this currency. The silver lining of having a sick currency is that GBP has a strong negative correlation with the FTSE 100, when the pound falls the FTSE 100 tends to rise. A weaker pound is also good news for companies in the FTSE 100 that earn in dollars, for example miners and oil giants like BP. Thus, a weaker pound could give FTSE 100 companies some protection against weaker Q3 earnings figures, which may also boost interest in this index.
4, Corporate good news and takeover targets: in a week that stock market bulls would like to forget, there were pockets of good news. For example, the Diageo chief executive gave an upbeat trading update on Thursday, saying that it had made a strong start to the new financial year and that it had seen organic net sales momentum across all regions. Perhaps the fear of stagflation is driving people to drink! The CEO also said that resilient consumer demand was mitigating supply chain issues. This resilience is expected to boost its organic operating margin this year due to consumers moving towards premium brands. Investors love an increase in margins, so this should be good news for Diageo’s share price in the coming months, as investors rush towards a dwindling number of stocks with good growth potential. Added to this, there could be heightened interest in the FTSE 100 as a target for corporate takeovers. A weaker pound tends to trigger interest in UK companies from their foreign rivals, so we could see M&A interest also boost the FTSE 100 in the coming months. This weekend, Morrison’s will be sold at an auction, as a way to resolve a hotly contested battle to buy the supermarket giant. This could trigger some volatility in its share price at the end of this week, and it may fuel general interest in the FTSE 100 in the coming days.
As you can see, there are good reasons to be optimistic that the FTSE 100 could outperform in the current environment. After 18 months’ of being left on the side lines, the FTSE 100 could come centre stage.
