A market index is essentially a hypothetical portfolio. More popular index funds consist of a country’s top companies or an industry within the stock market. Britain’s main index is the FTSE 100, which consists of the nation’s top 100 companies.
It has managed to stay level since the start of the year, while its counterpart across the Atlantic, the S&P 500, has seen a decline of 10%. The reason behind the two indexes’ different fortunes could be down to their respective constituents.
IPOs don’t like playing FTSE
For the last couple of years, the FTSE 100 has consistently underperformed its US equivalent, at least until recently. The reason for this was a lack of tech and growth companies in the index, as many of these firms opt to list in the US. This is due to the more stringent listing requirements for companies to list on the London Stock Exchange. These include:
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- Minimum market capitalisation of £700,000.
- Minimum 25% of shares in public hands.
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London has historically sought to limit the influence of individual executives, which has deterred many tech companies that are often founder-led. The additional stamp duty to purchase shares also stifles trading volume, presenting another disadvantage for stocks.
No tech, no problem
The FTSE reflects outsized weightings in energy, commodities, and financials. In fact, these three industries account for almost half of the UK’s main index. The S&P, on the other hand, only has 16% of its constituents in these three matured industries.
Due to sky high inflation, the US Federal Reserve has had to hike interest rates. Rising interest rates are normally conducted to slow consumer spending down from higher borrowing costs. So, how has this affected the S&P 500? Given that most technology and growth stocks are valued based on potential future cash flows, a slowdown in overall consumer spending can take a huge chunk off its valuation. This has been evident as tech stocks such as Meta have seen its share price decline 45% from its all-time high.
Simultaneously, FTSE-listed stocks have enjoyed immunity from the weakness of their tech peers. For one, energy stocks such as Shell and BP have enjoyed the tailwinds from rising oil prices. Moreover, high commodity prices in iron ore, copper, and aluminium have also held the index up. Financial stocks, including banks, have also benefited from rising interest rates. This trend is expected to continue in the short to medium term. The outlook for commodities, especially energy and materials, remains solid as the global economy continues to recover from the pandemic.
The million pound question
Is investing in a FTSE 100 fund a good investment for my portfolio then? Well, the British stock market is currently one of the cheapest in the world. It’s trading at a price-to-earnings (P/E) ratio of 14, far lower than the S&P 500’s 16. It also has a projected earnings yield of 13% over the next year, which is forecasted to be twice as much as the S&P.
On that basis, I’m keen to invest in the FTSE 100 for my portfolio through index funds like Vanguard FTSE 100 UCITS ETF (VUKE). Nonetheless, I also see a buying opportunity for the S&P 500, given its incredible track record of producing outstanding returns.
