An the UK stock market, all eyes are on the central bank this week. Will the Bank of England decide to raise interest rates by 0.5 percentage points? According to most analysts, this should come after the Federal Reserve Governor Andrew Bailey has already given hints. Sanjay Raja of Deutsche Bank in London expects the Bank of England to hike by half a percentage point this Thursday. “That would raise the key interest rate to 1.75 percent, it would be the bank’s biggest rate hike since 1995 – and its biggest step since independence,” he says. The British central bank probably does not want to fall behind the American central bank in the fight against inflation.
FTSE 100 continues to rise
Higher interest rates have not pushed the London Stock Exchange into the red this year. On the contrary: The British stock index FTSE 100 is one of the very few well-known indices that has been slightly up since the beginning of the year. Investors who entered the London FTSE 100 on January 1 are now almost 1 percent richer. All other major indices have lost more or less significantly, be it the American S&P 500 (down 14 percent since the beginning of the year), the German Dax (down 16 percent), the French CAC 40 (down 11 percent), the Spanish Ibex (down 7 percent) or the Italian MIB (minus 19 percent). “The FTSE 100 was one of the best-performing indices worldwide this year, despite the relatively difficult economic backdrop at home,” Goldman Sachs analysts led by Sharon Bell write in a recent report.
Now you have to take into account the appreciation of the dollar by a good 10 percent, which means that the S&P 500 investment looks better, although it is still down. The index of the London Stock Exchange is also ahead when adjusted for exchange rates. Why is that? Great Britain is no better off economically than others. Inflation is rising, the economy is slowing down. According to the IMF forecast, GDP is likely to increase by 3.5 percent this year, but next year Great Britain threatens to bring up the rear of the G-7 countries with an increase of only 0.5 percent. So why is the FTSE 100 leading so far?
According to Goldman Sachs analysis, four factors are crucial when comparing the UK and US markets: The movement is correlated with the development of interest rates, with the relative importance of “value” versus “growth” stock values, with the oil price and the pound-dollar exchange rate. The latter two factors are easy to explain: when the pound falls relative to the dollar (or rises relative to the pound), FTSE 100 corporate dollar sales and earnings become more valuable. The FTSE corporations are very global, earning three-quarters of their revenue overseas and about a quarter in dollars. Therefore, the appreciation of the dollar plays an important role for the London Stock Exchange.
Rising interest rates weigh heavily on the American stock market
The oil factor is also easy to understand: the FTSE lists a disproportionately large number of heavyweights from the oil and gas industry. Energy companies make up more than 12 percent of the FTSE 100. Goldman Sachs estimates that almost a fifth of UK companies’ profits come from the energy market. The main focus is on BP and Shell. They have benefited from the soaring oil and gas prices and reported record profits. The BP price has increased by around 11 percent since the beginning of the year, and the Shell share by more than 25 percent. All stocks in the energy sector on the London Stock Exchange’s FTSE 350 combined have risen by an average of 28 percent this year.
Goldman Sachs’ value versus growth stocks factor has also played an important role this year. In stock market jargon, for example, stocks from the energy, raw materials and banking sectors are referred to as “value”. These are heavily represented in the FTSE. After all, bank stocks have increased by an average of 6.7 percent this year and thus supported the overall market. In contrast, “growth” stocks such as tech companies, whose valuations have long driven up the American stock exchange, are not prominently represented in the index in London. This has tended to hold the FTSE back in recent years, but has helped this year as many growth stocks have tumbled badly.
Related to this is the issue of interest rates. According to the Goldman analysis, bond yields this year have been closely correlated with the relative performance of the FTSE and S&P: From January to June, US 10-year Treasury yields have risen by 2 percentage points. Rising interest rates have dealt a blow to many tech stocks. This weighed on the American stock market much more than the London index.
Will the trend driven by these four factors continue this year? Goldman Sachs believes so with regard to the price of oil. Analysts at the investment bank estimate that Brent will be listed at $130 a barrel over the next six to twelve months. That should continue to help the oil and energy majors on the FTSE. When it comes to real interest rates, the picture could be mixed. Weaker growth or even a recession could depress interest rates, but so can inflation. A lot on the stock exchanges is likely to depend on the issue of inflation and the central bank’s interest rate policy.
In London, the Bank of England could slow down after what is likely to be a big move this week. That’s what some analysts expect. BNP Paribas sees only a quarter of a percent gains coming. Bank of America says interest rates could rise in smaller increments to 2.25 percent by November.
