The FTSE 100 (INDEXFTSE: UKX) has been on a tremendous run so far this year. Year-to-date the index is up 10.3% excluding dividends and after this impressive performance, it’s beating its leading US counterpart, the S&P 500, by just under 4%. Year-to-date the S&P 500 is up by 6.7% excluding dividends.
And it looks as if the FTSE 100’s rally is set to continue throughout the rest of the year if sterling remains weak and FTSE 100 constituents report steady earnings growth.
Charging higher
Most of the FTSE 100’s gains over the past six months can be traced to the falling value of the pound. Around 70% of the profits from it come from overseas, so as the value of the pound falls, earnings, when translated back into sterling, will rise.
Unfortunately, higher earnings as a result of a weaker currency have no real fundamentals to support them. If sterling returns to the levels seen before Brexit, these currency gains will be wiped out leaving investors short-changed.
Still, with many analysts expecting the Bank of England to cut interest rates again before the end of the year, it’s most likely sterling will remain weak or even fall further during the next few months.
But it’s not just a weak pound that should push the UK’s leading index to new highs this year. Following the Brexit decision, shares in some of the UK’s largest domestic companies slumped. The housebuilders, Barratt Developments, Persimmon and Taylor Wimpey, have been particularly hard hit with shares in Taylor Wimpey falling by as much as 40% on the day after the referendum.
However, so far the UK housing market seems to be holding up relatively well, although shares in the housebuilders are still trading below pre-Brexit levels. Other companies such as ITV, Lloyds and Legal & General are all still grappling with post-Brexit hangovers. While the full fallout from Brexit isn’t yet known, over the next few months as the details of divorce are thrashed out, shares in these companies should start to regain some lost ground as the uncertainty is removed.
Hard to predict
While it looks as if the FTSE 100 is on course to hit a new high this year, I should say that it’s almost impossible to accurately predict the direction of any market over an extended period — if it were easy to predict the market’s direction all investors would be a lot better off.
With that being the case, investors shouldn’t bet the house on a FTSE 100 rally. Broad diversification is essential when investing, and diversification means diversifying both inside and outside your home country, as well as diversifying across sectors and company sizes.
For example, while the FTSE 100 is up 10.3% year-to-date the MSCI Emerging Markets Index has gained 16.2% so far this year, excluding dividends, as investors return to emerging markets following better than expected growth figures.
