Just over a year today, a divided Britain charged to the polls and narrowly elected to exit from its more than forty-year membership of the European Union.
Since then, a dividend market continues to disagree on the economic health of the United Kingdom and its prospects to go it alone. In a dizzying fog of exhausted slogans, there has been no shortage of barometers touted by the economists and commentators of both camps, yet the country’s foremost equity index stands to hold the highest claim to the most blinding of signals for the last 12 months.
Heavily overweight in recently repaired commodity and energy markets and satiated with international conglomerates grinning at a diminished sterling, the media and markets alike would do well to look beyond the FTSE 100 and 250 as an indicator for the post-Brexit health of Britain.
More Metal than Most
The FTSE 100 isn’t a balanced index by any stretch of the imagination. A market-cap weighting criteria leaves only the top century of gargantuan tickers in the index on each rebalancing and the band of international firms involved in resource extraction that call London their home are no strangers to size. BP and Royal Dutch Shell are the third and fourth largest constituents by weight in the index, together sharing over 9% and only second to the likes of HSBC and British American Tabacco.
“Its burden of resource stocks means the FTSE 100 should not be considered a safe tracker-type investment.”
Thomas Pearce, Equity Strategist, Deutsche Bank
Even after declines towards the end of 2015 in the market capitalisation of oil and energy stocks from £244bn to nearly £180bn, constituents with an exposure to commodity prices make up nearly a quarter of th FTSE 100’s composition.
It has been a historical feature of the index as a steady stream of resource giants have migrated to what many see as the international capital for metals and energy. Indonesian coal miner Vallar listed in London in 2010 along with the Tanzanian assets of Canadian Barrick Gold in the same year. The following year saw Glencore set up shop alongside the already staple BHP Billiton, dual-listed on the ASX and LSE.
Whilst a vital part of London’s claim to the world’s financial centre, the concentration of mining and energy firms leaves the FTSE some 14% overweight its peers, as other western aggregate equity indices settle for a total of 6% for all commodity-related constituents. That means where copper and oil go, the UK’s front of house index will follow, and that can mask any sight of the underlying British economy, and that could not be more true and prevalent than in the year since the Brexit vote.
Glencore, the Anglo-Swiss mining giant, has been the best performer in the FTSE 100 in the last 12 months as iron ore prices recovered and it is in good company not just in the FTSE 100 but in the 250 as well; Chilean copper miner Antofagasta was the third best performing constituent in the UK’s main index, whilst Ukranian iron ore miner Ferrexpo and Kazakh copper miner KAZ Minerals both made the top ten of the FTSE 250’s best performers list.
Commodities took a serious hit following oil’s demise from $100 a barrel in the middle of 2014, but are starting to pare those losses three years later. Whilst demand has recovered in key periphery economies, a dovish US Federal Reserve voted in March to raise key interest rates by 25 basis points but caveated any further raises as ‘gradual’, has sent the dollar considerably lower from the start of 2016. Whether it is barrel, tonne or gramme one is buying, all global commodities are denominated in greenbacks, meaning a cheaper dollar is a buy order for metals and energy.
The FTSE’s International Focus
If that is not enough concern in using the FTSE UK indices as a proxy for the country’s economic growth, one need not look further than their constituents’ lack of national exposure. Credit Suisse estimated last year that some 77% of sales for FTSE 100 companies come from outside of the United Kingdom, and in combination with a decimated pound sterling there is an undeniable windfall for multinationals when reporting.
report in dollars
If one is tired of hearing the words ‘overseas earnings’ that are never followed with the explanation, it is quite simple: a company converts all of its earnings into its reporting currency when issuing financial statements, which when the pound depreciates means that the hundred euros one earned in France is now not worth £80, but £90, and one has not moved a muscle. How much of the FTSE’s performance is attributable to this windfall is difficult to estimate, but it is yet another layer of cloud for what is supposedly an indicator of national growth.
The Financial Times makes the point that even the FTSE 250, touted as the real bellwether of the UK economy in comparison to its internationally-minded brother, is too inadequate as an indicator. The 250’s weighting towards resource companies only reaches 10% however almost a sixth of all companies are investment firms, with the majority of holdings outside of the United Kingdom.
In the case of recent addition Pershing Square Holdings the investment firm headed by Bill Ackman has 11 public investments, all of which are in North America.
According to the FT, neither the FTSE 100 or the FTSE 25o correlate with UK economic output since the Brexit vote or over a five year period. The 100’s weighting towards resource and energy creates a portfolio closer to a commodity index than an aggregate equity index, and a diminishing pound has done nothing to help the clarity.
Even the worst performers in the index have little to hold Brexit to account for; BT found fraud in its Italian business and Pearson publishing has lost significant market share in textbooks in key overseas markets such as the US.
Investors would do well to take some time away from the FTSE indices in this post-Brexit aftermath, lest we all get carried away with record highs and spurious correlations with economic growth.