The FTSE100 share index has rarely been out of the news since the UK voted to leave the EU. For media commentators it offers a visual ‘quick look’ at how the biggest public companies in the UK are doing (and by spurious extension, a flavour of UK business in general). With a country demanding clarity on the impact of the vote to leave the EU, using the performance of the FTSE100 is an easy way to create attention grabbing content.
For The Virgin Investor, the FTSE100 is likely to make up a part of their investment portfolio so it is worth understanding a bit more about what it is and the key drivers that affect the price of the index.
The FTSE100 is made up of the largest public companies in the UK across a range of industries. The size of a public company when determining its position in the share index is driven by market capitalisation – which is simply the value of all the shares in a company at a given point in time.
Naturally the make-up of the FTSE100 can change each quarter as companies grow and shrink or following significant mergers or acquisitions which change the market capitalisation of a company. There are entry bandings such that if a listed company that isn’t in the FTSE100 climbs to the 90th place or above, it is then eligible for entry into the FTSE100 index. If a listed company that is in the FTSE100 falls to 111th or below, it will fall out of the FTSE100 (and into the FTSE250 – the index representing the next 250 largest public companies by market capitalisation in the UK).
There are a huge number of variables at play when determining the direction of movement of the FTSE100 and investing largely depends on trying to understand the extent to which these variables have been considered in the price of the shares in the index. It would be impossible to draw up a fully comprehensive list of the variables that affect the FTSE100, there is a whole investment industry dedicated to trying to understand that, but here are a few of the main influencing factors to look out for.
Global business sentiment
A key point to understand is that many of the companies on the index are global companies – that is that they make a large proportion of their profits abroad. This means they are not entirely dependent on the fortunes of UK business but also on worldwide business confidence.
The central bank interest rate is set by the Bank of England in the UK and fundamentally affects the investment landscape in the UK. For example, a reduction in the central bank interest rate can make it cheaper for companies to borrow money which reduces interest charges and increases company profits, boosting FTSE100 share prices. Another impact of a low interest rate is to reduce the returns available from less risky investment products such as bonds and encourage investors to seek out returns in equities instead, further boosting FTSE100 share prices.
A change in value of the pound relative to other currencies can heavily impact FTSE100 companies as they will report their financial information in GBP but trade globally in a variety of currencies. For example, a weakening pound can make it cheaper for people abroad to buy the goods of these companies and so this will increase sales. Also another impact of a weakening pound is to draw in investment from abroad as it becomes cheaper for investors with funds in foreign currency to invest in a pound based index. Both these effects will cause the FTSE100 to rise in times of a weakening pound.
A large number of the biggest companies on the FTSE100 index are directly affected by the price of commodities (especially oil), for example those operating in the oil and mining industries. In general, a fall in oil prices leads the FTSE100 lower as money moves out of oil and mining industries due to lower revenues and also in recent months has caused investors to question global growth and move money out of equities in general.