Why Is The FTSE 100 Not At A Record High?

While other world stock markets have made record highs in recent months, the FTSE 100 is still lower than it was 14 years ago. But Royal Dutch Shell Plc (LON:RDSA) and HSBC Holdings plc (LON:HSBA) could drive an upswing.

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FTSE100

Since New Year’s Eve 1999, the FTSE 100 (FTSEINDICES: FTSE) has fallen by 1.5%. Although dividends have softened that blow somewhat, it is still a hugely disappointing result for long-term investors.

Indeed, comparing it to the S&P 500 highlights just how disappointing the performance has been from the leading UK share index because over the same timeframe the S&P 500 is up 33% and is all-set to make record highs in future. Here’s why the FTSE 100 is seemingly stuck in neutral.

The Mega Caps

Poor performance isn’t a problem for all UK indexes. For example, the FTSE 250 is up a whopping 144% in the 21st Century. So, it appears to be a FTSE 100 problem, and a key reason for it lagging behind other indices could be the performance of so-called ‘mega caps’ — the largest stocks in the index by market capitalisation.

The performance of mega caps matters a lot more than the performance of smaller companies when it comes to overall index performance. That’s because the FTSE 100 is a value-weighted index — the bigger the company, the bigger its impact on the index price. So, if the biggest companies experience poor performance, it is likely that the index as a whole will be down — even if the majority of stocks perform well.

A glance at the price to earnings (P/E) ratio of the FTSE 100 shows that it is relatively undervalued when compared to the FTSE 250 and S&P 500. For example, while the FTSE 100 trades on a P/E of 14.2, the FTSE 250 has a P/E of over 19 and the S&P trades on a P/E of over 16. This could mean that there is good value in the FTSE 100 on a relative basis and here are two mega caps that could see their valuations head north in future.

Shell

Despite posting strong gains in 2014 — its shares are currently up over 11% — Shell (LSE: RDSB) (NYSE: RDS.B.US) remains undervalued versus the FTSE 100. It trades on a P/E of 11.6 and continues to offer a greater degree of stability than many of its smaller sector peers. Furthermore, Shell’s strong cash flow means that it can afford a generous dividend. So, with its shares currently yielding 4.4%, there’s yet more evidence that Shell could see increased demand from investors in future. Certainly, profit growth may be minimal in the short run, but Shell’s asset base should provide a reasonable level of growth over the long run.

HSBC

Despite navigating the credit crunch rather more successfully than many of its banking peers (and emerging in better shape), HSBC (LSE: HSBA) (NYSE: HSBC.US) has struggled to gain ground this year. Indeed, its shares are down 8% year-to-date and now trade on a P/E of just 11.2 — well below the index P/E of 14.2. Although the top-line is not set to experience astounding levels of growth, cost-cutting and an efficiency drive should mean that profits grow at a double-digit rate over the next two years. This could attract investors and convince them that HSBC should trade at a higher price level.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Peter owns shares in HSBC and Shell.

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