The FTSE 100 vs the S&P 500

After years of massive under performance, the UK’s FTSE 100 is having its time in the limelight. The UK index has outperformed its US rival this year and this trend could continue. The S&P 500 has fallen nearly 16% so far this year, and even flirted with bear market territory during a particularly bad week for risk sentiment earlier this month. In contrast the UK’s FTSE 100 is up nearly 1% over the same time period. It has been an incredibly tumultuous start for financial markets, inflation is soaring, and interest rates are rising across the globe, however, the harbour in the storm during this period is the UK blue-chip index. We assess why this is happening and whether it will persist.

The FTSE 100 is not your traditional safe haven equity market index; however, it has certain qualities that are attractive to investors in the current environment

1, FTSE 100 is anti - tech

The tech sector has been under pressure in the last 9 months as the pandemic-era tech bubble has burst. Tech is a great investment when the economy is booming, and lockdowns leave people reliant on the digital world. However, inflation is like kryptonite for the tech sector. When prices started to surge, tech started to wobble. With inflation in the US now above 8% and interest rates rising rapidly, the investment community is reassessing the future outlook for tech. The problem is that the tech sector’s future earnings are discounted using current interest rates. When rates are rising, this reduced the future profits of the tech sector. Added to this, too many tech firms focussed on growth rather than profitability in recent years, take Peloton as an example. It's share price surged at the peak of the pandemic, however, it has now crashed more than 62% since the start of this year, as oversupply and swindling demand start to bite. Even tech giants such as Apple have come under pressure. Apple, Google and Amazon are all down 24%, 27% and 36% YTD respectively. The social media sector has fared even worse. Meta’s share price is down 45% YTD, while’s Snap’s share price is down nearly 70% YTD, after reporting disappointing earnings for Q1 and issuing a profit warning for Q2.

As you can see, things are bad for the tech sector. The good news for the FTSE 100 is that it doesn’t have any equivalent tech giants such as Apple, Amazon or Google. Since tech is such a large proportion of the S&P 500, it is being dragged lower by its poor performance. In contrast, the FTSE 100’s lack of tech companies is to its advantage in this environment. Going forward, the FOMC minutes from the May 4thmeeting suggest that the Fed wants to hurtle towards neutral interest rates as fast as possible to stem inflation, there is also a chance that the Fed will have to tighten rates past neutral to tame persistently high inflation, if the economy continues to hold up. Thus, there could be more pain to come for these tech firms. A more existential threat to the US tech sector is a permeant reassessment of what tech is and how it generates money. For example, the social media companies, Meta, Google and to a lesser extend Amazon, are advertising agencies in disguise as ads drive their revenues. Advertising firms are highly cyclical, so if the tech sector can’t generate profits in other ways, then we believe that there will be a larger risk premium associated with the tech sector now that it has proven itself to be highly cyclical and at risk from a weak economic environment.

2, Dividends are key

When inflation is surging and is likely to persist for some time, the market craves high dividend yields. We have been talking about dividends as being a big driver of demand for some corporate names this year, and it is now playing out at the index level. As it dawns on the market that inflation is likely to persist for some time, the dividend trade could be in demand for the rest of the year. The UK market has a projected dividend yield of 13%, compared with 7.5% for US large caps in 2022. Due to the FTSE 100’s dividend advantage, the UK index could continue to outperform the S&P 500 even if the tech sector does make a comeback.

3, Hot sectors

The other main reason for the FTSE 100’s outperformance is its constituent sectors. It is heavy on energy, materials and financials, all sectors that are thriving in the current environment. Financials tend to do well when interest rates are rising, although they may be stymied later this year as the global economy slows. However, even if financials slip, the FTSE 100 is still likely to benefit from the outperformance of the energy firms and materials companies. Natural resources have been surging this year due to supply concerns and the war in Ukraine. In the current environment, when risk sentiment is fragile, the market is focussed on stocks that make things people want. That includes oil, and with the oil price continuing to climb on Thursday, Brent crude is up some 1.2%, above $112 per barrel, it is hard to see when the oil companies share prices could tip over. Thus, we expect the FTSE 100 to remain in demand for some time yet.

4, Relative value

It’s worth noting that at the start of this year, the FTSE 100 was one of the developed world’s cheapest indices, which no doubt attracted investors who were sick of paying huge multiples for US stocks. While the best of the value has already been had, we continue to like the FTSE 100.

Overall, the market conditions remain favourable for the FTSE 100, and we continue to expect to see the UK index outperform in the coming weeks and months to come.

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