With foreign earnings dominating the FTSE100, do we need an index that better reflects the true state of the UK economy?
With foreign based earnings of FTSE100 index member stocks already likely in excess of 70% and the probable addition soon of Glencore fanning the flames, it can be argued that the main equity market index is no longer representative of the UK economy. Does that matter? I suppose that when the domestic economy is doing well it probably matters far less but when as now the economy is doing pretty badly the fact that the FTSE100 index is so often seen to be going in a quite opposite direction rise when all else around is talking national doom and gloom can make little sense to the ordinary investor. This begs the question whether bringing back the FT30 index could solve the vexing problem of there no longer being a UK equity index that could better reflect specific domestic economic and other events.
In calling for a partial re-examination of the current UK equity index system I make absolutely no criticism that the FTSE100 index may no longer be a true representative of the UK economy. Both the index requirement and the needs of most professional investors have moved on and I and others welcome the fact that over the past twenty-five years and particularly through the last ten that the LSE has both sought and successfully secured so many decent sized international mining and natural resource stocks to undertake partial IPO’s here in London. Indeed, that so many have chosen London has been absolutely great news for the market and for the most part those that over the years have chosen to invest in them. But having no specific index or stock weighting mechanism for companies that are more representative of UK economic momentum might, in these more difficult times, this be something of a mistake!
Over the years since its inception back in 1984 the FTSE100 index has been going evermore global. This change is not just about the number of new companies that have joined the FTSE100 index following various interesting IPO’s in recent years. It has also been about the number of listed FTSE100 stocks that have been continually expanding their earnings abroad. Banks and pharmaceutical companies come high on this particular list, as do energy companies and what we used to call utilities. Vodafone is another very good example and the same story is even true for the majority of earnings expansion from aerospace and defence engineering companies such as BAE Systems, Rolls-Royce and GKN and which has predominantly occurred from respective internationally based revenue expansion plans. In retailing Tesco earnings are another case in point as massive expansion across Asia continues to reap high revenue and earnings reward for the group. I suppose that if one was to remove J. Sainsbury, William Morrison, Marks & Spencer, ITV and maybe a couple of others from the FTSE100, it would mean that the level of foreign based earnings could maybe account for closer to 85% of FTSE100 index content or possibly even beyond that!
In its original form the FT 30 or FT Index if you prefer was based only on industrial companies though during the 1940’s and 1950’s oil and banking stocks were added. Unknown to many, the FT 30 index does still exist although changes to the index are marked only at the end of the trading day. With technology being what it is today I guess that very little effort would be required by the LSE to make the FT 30 live. That the FT 30 index contains no mining or natural resource stocks means that while it would still reflect a high proportion of foreign based earnings it would overall be a very much better reflection of real UK economic momentum (see further below for current list of member stocks).
From an investment perspective, that the FTSE100 has over the past quarter of a century gone increasingly global is excellent news for all investment professionals, funds and hedge funds plus all those that rely on tracker funds. With minute by minute reference to the rise and fall of the FTSE the danger is that some might be led to believe that positive stock market momentum when it comes could be a pure reflection on management of the UK economy. That said, these days it is noticeable how publication of higher or maybe lower UK inflation numbers, unemployment and trade figures plus quarterly GDP numbers and the like rarely make much of a direct impression on the momentum of the FTSE100 index. What dictates equity market momentum and most often direction of the FTSE100 today is far more likely to be about global geo-political and other events, evidence of change in global demand perhaps, both dollar and oil price momentum and, as often as not, fresh macro economic news from the US such as jobs and housing data. News from China in terms of any movement in growth or change in interest rates plus occasionally also news from Japan will also quickly reflect on the FTSE100 and other major global Markey index. Also true is that events in Euroland matter a lot as well meaning that the handling of the ongoing sovereign debt crisis did not go unnoticed in the FTSE100, the DAX, the CAC 40 and occasionally even in the S&P 500. Of course corporate earnings also matter but whether we like it or not unless it was particularly bad news from the mining and resource stocks and maybe Vodafone, corporate results are most usually dominated by those from the US.
Currently some five FTSE100 index member companies are incorporated outside the UK [WPP, Experian, Resolution, Shire, and Randgold Resources] although there was talk recently that WPP would soon come back into the UK fold. Thankfully it seems that fears of a handful of commentators who had suggested that because of the threat of higher taxation banks such as Barclays and HSBC might soon leave the UK registered company fold have proved to be unfounded. The FTSE100 remains in great shape and an extremely useful tool for investors. But that does not mean that the FTSE100 index or indeed, the more representative FTSE250 index are always the best tool for the investment job. Because it is a true representation across all equity sectors and maybe a better representation of the producer and consumer impact on the economy older hands amongst you will know that I have long been an advocate of making better use of the old FT30 index. Comprising the most significant company within a sector as opposed to the top one hundred in terms of market capitalisation the FT30 could even though it might retain a significant level of foreign based earnings provide a better representation of economic performance in relation to the actual state of the UK economy.
As I say, that foreign earnings dominate within the majority of FTSE100 index member stocks is no bad thing at all. Shortly, the addition of Glencore will likely not only further enhance the number of index companies that are incorporated outside the UK but also increase the percentage basis of foreign based earnings as well. That the FT30 index which still technically exists (see below) and yet is no longer being used by many for the simple reasons that currently it is only updated once a day does seem to me to be a ridiculous waste of a potentially very good index resource.
(Current FT 30 Index)
BG BP BAE Systems British Airways* BT Compass Diageo GKN 3i Invensys ITV Ladbrokes Land Securities Lloyds Banking Group Logica Man Group M&S
National Grid Prudential Reckitt Benckiser RSA RBS
Smiths Group Tate & Lyle Tesco Vodafone Wolseley
(* we assume this is now International Airlines Group)
Howard Wheeldon is the Senior Strategist at BGC Partners