While the FTSE 100 has risen by 8% in 2016, the FTSE 250 is up just 0.5%. A key reason for this is the greater international focus of the FTSE 100, as well as its lower risk profile. As such, it has benefited from a weaker sterling and the uncertainty which have been the dominant themes of 2016. Looking ahead to 2017, those same themes could cause the FTSE 100 to beat the FTSE 250 for another year.
Uncertain outlook
While Brexit and Donald Trump’s election victory have been major events in 2016, their full impact is yet to be felt. In the case of Brexit, the UK government has not yet begun the process of leaving the EU and is not set to do so until March 2017. Once Article 50 of The Lisbon Treaty is invoked, it is likely to lead to greater uncertainty in the UK’s economic outlook.
Negotiations between the UK and EU could prove challenging, since a two-year window is a relatively short time to organise trade deals, immigration agreements, and sort out the extent of the UK’s access to the single market. Investors may therefore seek safety in lower risk, large-cap shares, rather than buying FTSE 250 stocks.
Similarly, Donald Trump has not yet taken office. Therefore, uncertainty surrounding his Presidency may not yet have reached its highest point. Once he is in the White House and begins to implement his policies, investors may seek less risky investments in order to protect their wealth from the vast change that is likely to be a key feature of Trump’s first year in charge. Although this may hurt the FTSE 100’s performance to a degree, larger companies have historically been viewed as safer assets than mid-caps during challenging periods.
Sterling
While sterling has weakened considerably in 2016, it would be unsurprising for this trend to continue in 2017. US interest rates are likely to rise, as Donald Trump’s spending plans are set to have an inflationary effect. This could cause the Federal Reserve to adopt a more hawkish stance and raise rates at the same time as the Bank of England keeps UK interest rates at an all-time low.
Although inflation may be a risk for the UK, the uncertainty surrounding Brexit may lead to interest rates remaining low in order to provide support for the UK economy. And with inflation not expected to be in excess of 3% next year, interest rates may even have scope to be cut, which would be likely to cause a depreciation in the value of the pound.
This would be good news for the FTSE 100, since a majority of its earnings are derived from abroad. Therefore, it should experience a positive currency translation, while the more UK-focused FTSE 250 would benefit to a lesser extent.
Investing in the FTSE 100 rather than the FTSE 250 seems to be the logical choice for 2017.
