Alpesh Patel On The Markets

Why would you invest in the FTSE 100 right now?

A question that almost every trader and investor in the UK has in mind is quite simply “where’s the FTSE 100 headed a few weeks down the road?” I know this because from all the people I meet on various occasions this is the most posited question. To put it in simple words so we can really drill down to the core of it: is the FTSE 100 headed higher over the medium term or not?

Now this is a question that has no simple answer and the reason is that the FTSE’s performance doesn’t hinge on just one thing. When I am faced with a question as complex as this I first try to understand “the nature of the beast”, meaning to map out the various forces affecting the object of my interest and then see how these play out.

I will keep this plain and tidy because I know that many readers will find this analysis helpful. So here goes. The FTSE 100’s performance is influenced by roughly three forces: the performance of the British Pound, the interest rate policy and the performance of the other global indices, namely the major US stock markets. Now if we take each of these forces and detail how we expect them to affect the FTSE 100 over the next few weeks, we will get a good indication of its outlook, right?

Reading the forces

So starting with the British Pound, we can assess that Sterling has been trading relatively sideways against its counterparts in recent times. It has declined against the US Dollar, and I think it will continue to do so, but at the same time it has appreciated versus the Euro, and I believe this trend will also continue, especially with the Euro-zone now undergoing another easing programme. So to sum it up, I expect the Pound to remain flat on average against the other currencies. Thus I expect no upward or downward pressure on the FTSE from the Pound.

Now taking a look at the matter of the interest rate policy and the Bank of England’s future intentions, we know what they intend to do: raise interest rates. But we also know that they won’t do it soon due to two reasons: domestic economic progress is not yet sufficient and they probably want to wait for the US Federal Reserve Bank to pull the trigger first. The Fed will most likely pull the trigger some time after June, so no rate change from the BoE is expected either before that.

As long as the Bank of England leaves interest rates at their current levels, we know that this is a bullish indicator for the stock market as investors love cheap money supply. Hence we can count that as a precursor towards further gains for the FTSE 100, at least until the BoE becomes more serious about a rate hike.

But what about the US stock market and its correlation with the domestic stock index? It is true that the FTSE 100 takes its cue from the US markets most of the time, as investment sentiment is a global affair nowadays. And as I mentioned above, the Fed’s reluctance to hike interest rates means that the likes of Dow Jones and co. will have more room to continue to move on the upside.

Interestingly enough, at the same time it appears that the stronger Dollar doesn’t bode too badly for US companies either. According to a well circulated study from Goldman Sachs, a stronger currency doesn’t tend to weigh down on the domestic stock market. Actually, the study premises that the benchmark S&P 500 index’s performance is almost uncorrelated to currency moves, so an expensive Dollar doesn’t affect companies’ earnings expectations. So with the Fed keeping rates unchanged for now and a pricy Dollar not hampering companies’ growth, the US stock indices are looking bullish and they will affect the FTSE 100 accordingly.

The verdict?

So keeping score we find that two out of the three important forces weighing on the FTSE 100 suggest a further climb and one of them is neutral. Our conclusion should therefore be that the FTSE 100 seems more likely to break into fresh highs and take advantage of this low-rates environment for as long as it lasts.

And finally, with most people thinking “it can’t be, it needs to correct lower”, I think this looks as good an opportunity as any for the smart investors to make their move, catch the rest off guard and rake their profits. Oh yes, and a good opportunity for us to join them…

Happy Trading
Alpesh B Patel