World

A different way of viewing the world

24 May 2019

Ben Kumar, Investment Manager

The FTSE 100 is often referred to as the UK's premier equity index. It's not. Four fifths of its total sales are made outside of the UK.

The FTSE 100 includes the largest 100 companies that are listed in the UK. A listing in the UK means that a company will have an office in the UK, and its shares will trade on the London Stock Exchange, priced in Sterling. Some FTSE 100 companies do most of their business in the UK – Sainsbury’s or Auto Trader, for example.

However, many FTSE 100 companies are multinationals that do almost no domestic business here, in the UK. Their UK listing is a historical accident, or a matter of convenience. If you’re a company operating in the eight time zones between the UK and Singapore, then a London listing can be a helpful way of raising capital when needed.

As a result, though, it makes little sense to invest in the FTSE 100 on the basis of your views on the UK economy.

A case in point

Over 2014 and 2015, the UK and US economies both grew at around 2.6% per year. Interest rates were similar. Inflation was similar. Back then, there were no big political shifts to worry about.

But those two years were bad for oil – which fell by more than 60%. Other commodities were dragged down too – copper, natural gas and aluminium all lost more than 40%.

From an economic standpoint, oil is marginal to both the US and the UK. Energy and mining contribute roughly the same amount to each country’s economy – around 2% of US output, and 1.5% of UK output.

Yet in those twenty-four months the US equity market rose 11% while the UK equity market fell 8%. Why? The 20% difference in performance between the two indices had little to do with the underlying economies of the two countries, and far more to do with the sectoral exposure of their stock markets. It wasn’t Britain vs. America – it was the energy exposure of London-listed companies.

In Britain, many multinationals listed in London are in the energy and materials sectors. Some of the big names are familiar, such as BP and Royal Dutch Shell. Others are less well-known – Evraz, for example, was founded in Moscow in 1992 and now mines coal and iron ore in Russia, Canada, Ukraine, South Africa and Kazakhstan, to name a few.

These companies focus on making deep holes in the ground and selling what they find down there. When what they sell more than halves in value, they make less money – leading to their share prices falling. BP and Shell lost over a quarter of their worth during 2014 and 2015, while Evraz fell by more than a third. And because these types of companies make up nearly a third of the FTSE 100 any significant movements in their share prices will have a pronounced effect on the performance of the UK stock market.

American energy and materials companies felt the same pain, but because they represent less than 10% of the US stock market the impact is less severe. In fact the US equity market is actually closer to the underlying US economy – most of the companies listed in the US do the bulk of their business there, with three quarters of the S&P 500’s companies’ sales coming from America.

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