Market Activity


Is the FTSE currently undervalued?

Market Activity

Is the FTSE currently undervalued?

The first week of 2021 was full of optimism in the market. During the week the FTSE actually outperformed its peers for the first time in a long time. Can we read into this that a majority believe it is an undervalued index?

September 24, 2021

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The first week of 2021 was full of optimism in the market. Investors came in and started to position themselves for the year. During the week the FTSE actually outperformed its peers for the first time in a long time. Can we read into this that a majority believe it is an undervalued index? I think maybe we can, and I think maybe it is.

Less Uncertainty: With the EU-UK striking a Brexit trade agreement at the back-end of 2020 to end over 4 years of heightened political uncertainty, the reduction of this headwind, could see previously reluctant investors return to the market. It won’t be immediate as we still don’t fully understand the consequences of the break, but as time passes, and assuming economic armageddon doesn’t unravel, buyers will re-enter the market.

UK Equities Undervalued Relative to Peers: The FTSE 100 has been the underperforming index following the Q1 2020 crash. However, with a vaccine being rolled out, despite the recent surge in virus cases globally, leading to renewed lockdown measures, there is light at the end of the tunnel. In particular, for the FTSE 100, there is a sizeable amount of catching up to do, therefore, investors seeking value, could perhaps be best placed in a comparatively cheaper index, such as the FTSE 100.

So why has the FTSE been left behind? Well, this is predominantly due to the strength, or weakness in this case, in certain sectors. The FTSE does not contain much in the way of tech; in fact, only 1.3% to be precise. This will hopefully change in the coming years, but for now, the top UK 100 companies are mostly consumer staples (19%), banks (17.2%) and commodities (Energy and Utilities 12.9%). In short, it is an old fashioned, industrial looking index.

In contrast to this, the top 5 US companies in the S&P 500 are Apple, Microsoft, Amazon, Alphabet (Google) and Facebook. These are also now the 5 most expensive companies in the world by market cap. If we go by revenue, Facebook isn’t even in the top 50. It is a market filled with growth stocks and the world rushed to them when the virus hit. I wrote back in June that the virus would likely start a new tech bubble, and this does seem to be a case. Having said that, it’s not a bubble if it doesn’t burst and I’m not sure I’d bet against any of the aforementioned companies to fulfill their expectations.

So, the global investment market moved money around during the crash. The call was to get out of value and into growth/quality. Sell financials and energy and buy tech. In indices terms, this means sell the FTSE and the CAC and buy the S&P and the Nikkei. If we look at the graph, we can see this is exactly how it played out. But what happens next?

New institutional investment is unlikely to look to the mega cap tech in the US until prices look more reasonable. I would imagine they will mostly move sideways for a while, propped up by retail investors picking the stocks they know, therefore not providing much in the way of return. For this, we have to look at the value stocks that have suffered but will recover over the next year or two, and for this reason, we like the FTSE.

To summarise: investors will look for an upswing in economic activity to spark global economic growth, the reflation theme is likely to support those sectors with exposure to commodities, alongside the financial sector, which has been recently underpinned by the pick-up in bond yields. This is important to consider, given that the FTSE 100 has a relatively high exposure to commodities and financials. Alongside this, as concerns grow over excessive valuations across the tech sector, money may flock to those indices with limited tech exposure, such as the FTSE 100, in a reversal of the extremes caused by Covid-19.

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