Yesterday morning I was eating my breakfast when a notification popped up on my phone. It said the Bank of England had cut interest rates by 0.5%, to set a new rate of 0.25%. I expected the Bank to have to step in at some point and cut interest rates to limit the impact of the coronavirus on the UK economy. But it surprised me that it cut rates outside of the normal meeting schedule.
The cut came in the morning and the FTSE 100 index actually closed the day down 1.4%. You might be surprised at that, but dig a little deeper and it becomes clearer.
FTSE 100 and interest rate correlation
Ignoring coronavirus issues for now, historically, cutting interest rates sees the stock market rallying. This is primarily because most major publicly listed firms have a large debt exposure. The rates at which these firms can borrow from the banks is largely dictated by the base rate set by the BoE. Thus, with the rate falling, this means they can borrow at a cheaper rate. That is good news. Lower costs means greater potential for higher profit, usually boosting the share price.
What happened then?
The FTSE 100 was actually closed when the announcement came through at around 07:00 (hence why I was still enjoying my Weetabix). But a quick look at the futures market (which gives a price for the stock market outside of normal working hours) showed the FTSE 100 price did jump higher when the announcement came out.
Over the course of the day, all of these gains were lost, and the market ultimately finished much lower. This can be put down in part to the budget announced by the Chancellor. He outlined financial packages to help support businesses. But the feeling was that it did not go far enough and the market was disappointed overall.
Further, the US stock markets opened and traded lower into the afternoon here in London. At the moment we are seeing a large global correlation between the stock markets around the world. In essence, if the US stock market is falling, there is a very strong chance the UK stock market will follow suit. This happened on Wednesday.
Finally, some of the fall at the end of the day can be attributed to dividend payouts from individual firms. When a firm pays out a dividend (known as going ex-div), the price of the firm drops by the amount of the dividend to counterbalance the anticipation of it. Overall, the FTSE 100 will drop as well when several firms go ‘ex-div’ around the market close, which happened Wednesday.
What should investors do?
From this my take is that the FTSE 100 is impossible to predict on a day to day basis at the moment. I do not think that rushing in to buy individual cheap stocks now is a reliable way to make a profit. But I definitely do not think that selling on a short term basis is a good move either. That way, paper losses will become real losses.
So what would I do? I think the huge sell-off we have seen over the past month make the FTSE 100 index a buy for the longer term. This is why I bought a FTSE 100 tracker two weeks ago. You can find out more of my reasoning for this here.
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Jonathan Smith and The Motley Fool UK have no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.