Back in July with the FTSE 100 (INDEXFTSE: UKX) at 6,680, I penned an article speculating that it could reach 7,000 by Christmas. Since then, things have gone rather well for London’s lead index, which is knocking on the door of 7,000 already — 6,906 today as I write.
Markets go further than we think possible
Markets tend to go further than we think possible when they’re trending, according to one-time hedge fund manager Richard Farleigh in his book Taming The Lion. On top of that, markets hitting new highs often go further up rather than suddenly reversing. With those rather woolly concepts in mind, maybe I should revise my Christmas target for the FTSE 100 to 8,000.
I was far too conservative in July it seems, so let’s run through some of the factors that seem to be driving the index right now.
The weak pound
In the run-up to the Brexit vote, the stock market seemed to me to be in a held-back state. Many investors were cautious about the possibility of volatility and took money out of shares. Before the referendum, I thought that we might see a relief rally in shares regardless of the outcome of the vote, because investors as a whole seem more unsettled by uncertainty than by anything else. That rally seems to be happening, perhaps driven in part by investors generally returning to shares, but also by the effects of the weaker pound.
When the pound is weak against other currencies such as the euro and the US dollar, share prices of internationally trading firms go up because foreign earnings are worth more when converted back to pounds. Many of the companies populating the FTSE 100 report earnings in sterling, so they’ve benefitted from this perhaps one-off currency conversion boost.
A ‘flight to quality’
We also seem to be seeing a ‘flight to quality’. Many FTSE 100 firms rising on the London stock market operate in defensive sectors such as consumer goods, pharmaceuticals and utilities. Such sectors become even more attractive to investors in times of economic uncertainty.
Resurgent UK-facing cyclicals
Before the referendum, respected fund manager Neil Woodford commissioned a study by several experts that concluded the economic consequences of Britain leaving the European Union would likely be neutral. While it’s true that we haven’t actually left the EU yet, so far, much of the doom and gloom peddled in the run-up to the vote has failed to materialise and I think the sell-off of UK-facing cyclicals is starting to look as if it was overdone. Any economic weakness caused by Britain’s vote to leave the EU looks like being mild or non-existent for now, so it makes sense that the cyclicals could continue to rise between now and Christmas.
Good investor liquidity and monetary stimulus
If investors continue to reinvest money that they withdrew from the stock market before the referendum, the liquidity could help drive shares up a long way. During the global financial crisis of 2008/09, the flow of money in the economy seized up. Today, the situation is different. Companies, investment institutions, rich private investors and banks are all awash with capital that’s free to invest.
Meanwhile, The Bank of England has been talking about using “sledgehammer” stimulus to cushion the economic shock of Britain’s vote to leave the EU. A recent cut in interest rates and a pledge to spend billions more on quantitative easing are both likely to drive markets higher.
