Britain’s economy is struggling – so why is the FTSE 100 at a record high?

Britain’s economy is struggling to emerge from a shallow recession, afflicted by sky-high interest rates and persistent inflation. Yet the FTSE 100 is flying, setting fresh records daily.

Those outside the City could be forgiven for wondering what on earth is going on, but there are good reasons for the sudden boom – chiefly, the weak pound.

The FTSE is weighted by its constituents’ market value, so a 1 per cent increase in the price of shares in drug giant AstraZeneca – a business valued at £177bn – will have far more impact than, say, a 20 per cent rise in the price of EasyJet, whose market value is £4bn. Firms at the top of the index – such as Astra Zeneca – are multinational dollar companies for whom the UK economy has little impact on earnings except for the strength of sterling. While these companies’ shares are priced in GBP, their earnings come in USD; when the pound is weak, as it has been lately, those earnings become more valuable and share prices rise.

Russ Mould, investment director at AJ Bell, said: “Since the FTSE 100 gains around two-thirds of its earnings from overseas, the weaker pound boosts the reported profits from the index’s constituents, on an aggregate basis, because of the translational benefits – it is just mathematics.

“This is particularly powerful as some of the FTSE 100’s biggest earners – Shell, HSBC, BP, Rio Tinto, British American Tobacco, AstraZeneca, GlaxoSmithKline and Unilever are the top eight [earners] based on analysts’ forecasts for 2024. All have substantial foreign earnings. Between them, those eight represent half of the forecast FTSE 100 profit on their own.”

Another driver is the expectation that interest rates will come down (which also weakens the pound). That remains the case even if the outlook has lately got a little cloudier than it was. Shares are a more attractive investment when interest rates are lower, despite the risks they pose.

“The forecast dividend yield is nearly 4 per cent. Share buybacks [another means by which companies seek to return cash to investors] are adding another 2 to 2.5 per cent in cash returns and takeovers another 1 to 1.5 per cent, for a cash yield return of some 8 per cent – a figure that beats cash in the bank, government bond yields and inflation,” says Mould.

The FTSE has also greatly underperformed its peers recently. A Goldman Sachs analysis from earlier this month, for example, found it to be priced at 11.3 times its constituents’ expected earnings over the next year. This is towards the bottom of its historic range and compares to 21.4 times for the US market, Japan’s 15.7 and 13.7 in Europe.

Low prices draw in money, which makes prices rise, which will narrow the FTSE’s discount to its peers. Another advantage the UK market enjoys in the midst of the current uncertain global situation is that it is seen as defensive. It is a safe(ish) place to shelter when the international weather is stormy. Its top companies are quite boring: big banks and natural resource companies. But they are reliable earners with reliable dividends. Even the more exciting big pharma stocks can be counted upon to pull their weight in this respect.

It is worth remembering that all is not rosy in the London Stock Exchange garden, even if investors are waking up to the fact that its constituents are as cheap as chips. The market has struggled to attract new listings of late. British techs, for example, have largely shunned it in favour of Wall Street’s ready supply of moneymen with a strong desire to get their hands on the next big thing and a willingness to roll the dice to do that.

Some of its biggest established names, high-profile blue chip companies, have also headed for the exit in search of deeper pools of capital and especially higher valuations in New York, Frankfurt and even Australia.

Miner BHP headed for the latter, which actually made a lot of sense given the location of its operations, HQ and centre of gravity. However, the motivations of other leavers should be of more concern. Smurfit Kappa, a packaging company, plumbing supplier Ferguson and CRH, a building materials group, have all flown across the Atlantic. Flutter, the gambling group which owns Paddy Power, is looking to do the same. Pollster YouGov has mooted a similar move. Tour operator TUI is heading for Frankfurt. British chip designer ARM, the jewel in the crown of what remains a decent tech sector, opted for New York when its Japanese owner SoftBank returned it to public ownership.

Once London basked in the glow of having the world’s most international market and was lauded for its deep pool of capital, sensible regulation and enthusiasm for welcoming overseas listings. But that shine has been covered by a heavy coat of tarnish.

One of the major reasons for this is of course Brexit, which pumps toxic waste over almost everything. London was once seen as the gateway to Europe and the place to go for companies eager to tap into the world’s biggest single market. Brexit has changed that, leaving the City of London diminished.

Critics have also asked whether the City’s “gold standard” regulation is in need of a polish. The government has been attempting to address this. It would also like pension funds to do more to support UK businesses too. They have been markedly underweight in the UK market compared to their peers. Regulation has played a role here too.

Mould argues that by far the best corrective for an undervalued market is simply low prices because investors will always seek out value. But a debate over whether the UK is doing enough to maximise the potential of its once world-conquering financial centre is underway. It is very necessary, even after taking into account the FTSE’s barnstorming recent performance.