Something I am often asked is why the FTSE 100 stock index has under-performed compared to the German Dax and the S&P 500. In this piece I will look at the three markets to compare and contrast and ultimately give you an understanding of why the UK stock market has lagged.
As a bit of background, since 2010, the FTSE 100 index has risen 20% compared with the S&P 500 index, which has gone up by 88% and the German Dax, which has increased by 68%. This is a notable difference; with the FTSE evidently facing a much slower climb.
If we analyse the FTSE 100, starting with the basics, it is an index of the top 100 companies by market capitalisation traded on the London stock exchange. Now, if we look at what it comprises of, we can see that it is primarily made up of businesses whose income is derived overseas. Breaking it down further, 25% of those companies are in the natural resources sector and 18% in financial services.
In the decade preceding the financial crisis, China was the fastest growing economy in the world and the biggest buyers of natural resources. Since the financial crisis, China has slowed their economic growth, which has led to a decrease in the price of the commodities that the natural resource companies sell to them. This has therefore contributed to less profitable earnings and a slower growing stock price to match. This, along with well publicised incidents surrounding the British banking sector, has led to a lag in performance of our major index.
Within the UK there is also the FTSE all share index, which includes the top 1000 companies traded on the London stock exchange by value. This index, which has a more even sector weighting, has out-performed the FTSE 100 by 6% over the last 5 years because it is less reliant on the success of specific industries.
Now let’s look at the German DAX index which is made up of 30 of the largest German companies and mainly domestic businesses. Within the Index, 30% of the constituents are in the manufacturing and engineering sectors, which since the recovery from the global financial crisis, has only seen an increase in the volume and value of exports made by German companies to the rest of the world. This partly explains why we have seen the 88% increase in the DAX since 2010.
In my opinion, the American S&P 500 index is the best index for viewing economic growth, especially if compared with the UK and Germany, as it comprises of the top 500 US companies and therefore is a much larger pool to examine. With an even sector weighting, investors can see a fair picture of growth without bias toward particular sectors performance.
With all of this in mind we can now look at the investors themselves. Often, before anyone begins a long-term investment, they will ask themselves which stock index will perform best and be worthy of their capital. As a result, many will make the decision to invest in their domestic equity markets as it avoids any currency risk on foreign stock purchases.
At a glance investors would see our stock market as one which has under-performed compared to its peers, but once the information is broken down it can be seen that the FTSE 100’s investment case is one of longer term growth and a recovering Asia, making it more of an indicator of global performance. There has not been a time in recent years where UK equity markets have lagged the rest of the world by such a considerable margin, thus making a better case for upside growth on a longer-term investment.
The question for investors is whether they believe that over the longer term the growth in China will pick up and, in turn, commodity prices and mining stocks will rise. Or, whether it will be manufacturing or technology, which also has grown phenomenally over the last decade, that will be the main drivers for future growth in public equity markets.
