The FTSE 100’s recent performance has been nothing short of superb. It has risen by 15% in the last six months on its way to over 7,000 points. This has taken many investors by surprise since the outlook for the UK and global economy is uncertain. However, weaker sterling has provided a boost to the FTSE 100’s internationally-focused companies. Looking ahead, these two factors are likely to dominate the FTSE 100’s performance in future.
Risks
As mentioned, the outlook for the UK and global economy is challenging. In the UK, Brexit is likely to cause a huge amount of uncertainty which could easily turn into fear. As yet, economic data has been relatively robust, but we mustn’t forget that the process of leaving the EU has yet to begin. As such, things could get much worse before they get better.
Similarly, the global economy faces uncertainty. In the US, interest rate rises are becoming increasingly likely as jobs data and other economic data has pointed to continued recovery. This could force the Federal Reserve’s hand to increase interest rates in order to cool off potentially higher inflation.
Meanwhile, in China government stimulus has boosted its short-term economic performance but its GDP growth rate is still expected to fall in the coming years. How easily it’s able to transition towards a consumer economy will be an important factor in the FTSE 100’s near-term performance. If short-term economic data disappoints then it could easily wipe hundreds of points off the FTSE 100 in a relatively short space of time.
Positive catalysts
However, the risks are offset by potentially positive catalysts. Chief among these is a weaker pound. Although sterling has recovered somewhat from its overnight ‘flash crash’, the reality is that it’s still falling. It’s now just £1/$1.24 and is showing no sign of slowing its downward march. Further loose monetary policy from the Bank of England could make the pound even weaker, while a US interest rate rise would do likewise.
In such a situation, the FTSE 100 would be a major beneficiary. Most of its constituents aren’t particularly focused on the UK, but they report in sterling. Therefore, a weaker pound would have a positive translation effect and cause their profitability to rise even more than expected.
Of course, the FTSE 100 continues to offer good value for money. It has a dividend yield of 3.6% versus 2.2% for the S&P 500. This indicates that on a relative basis, the FTSE 100 has scope to rise by a significant amount over the medium term.
Outlook
The FTSE 100’s recent rise looks set to continue. A weaker pound is having a very positive effect on its performance and this is showing no sign of changing any time soon. Although the FTSE 100 faces key risks such as US interest rate rises and a slowing Chinese economy, it remains a great place to invest for the long term.
