Interactive Investor

Why FTSE 100 just got interesting

30th June 2017 12:30

Lee Wild from interactive investor

As the first half of 2017 nears a close, we're talking about another grim period for the FTSE 100 and other major markets, and not for the first time in recent weeks.

A well-established inverse relationship between sterling and the export-driven FTSE 100 has blown a hole in the blue-chip index, and it's easy to understand why we're all asking whether this is the long-promised correction.

And it's a good question. Since troubling 7,600 at the beginning of June, the FTSE 100 has handed back as much as 280 points, about 3.7%. The FTSE 250 is down as much as 805 points, or 4%, and AIM about 30 points, or 3%.

In the scheme of things, it's hardly a surprise. Markets never go up in a straight line. There must always be a pause, or minor correction. It's about letting profit takers get out, and new money get on.

This year alone, we've seen the leading index pull back by 3.5-4% twice - in January and again in April. This month's bad run makes it three.

Clearly, stock valuations are stretched and earnings need to catch up. During US reporting season, meeting expectations for strong profit growth during the second quarter will be crucial.

Any misses will be punished severely, and any sell-off could broaden if there's evidence that shortfalls are not isolated to specific stocks or sectors.

We've already seen US tech plays have a couple of wobbles recently, although selling has been modest in the context of the stellar performance post the financial crisis.

Back in the UK, it's interest rates that have caused most excitement. After first hinting that borrowing costs would not rise, Bank of England governor Mark Carney now says "some removal of monetary stimulus is likely to become necessary".

Despite Carney apparently merely stating what is obvious to most of us, currency traders jumped on the more hawkish tone, chasing sterling up as much as 3.5% and back above $1.30 for the first time since May.

A weak pound has been great for the exporters that dominate the FTSE 100. Converting overseas earnings back into a cheap domestic reporting currency does wonders for the numbers.

Mid-caps benefit, too. There are plenty of major exporters there, so share prices have soared. But a weak pound has made imports more expensive, which forces up prices on the high street and causes concern around above-target inflation.

However, all the hullabaloo around rate rises had bank shares higher this week, with any increase in borrowing costs typically a boost to margins. There was also a positive read across from news that US banks had passed the Federal Reserve's stress test.

HSBC, also helped by positive broker comment, Standard Chartered, Barclays, and even Royal Bank of Scotland, have done well. Miners Anglo American, Rio Tinto and the rest were buoyed by a weaker dollar.

It's the more expensive stocks that litter the bottom of the performance table, among them utilities Severn Trent and National Grid, while there's been profit taking at both Sage and Rolls-Royce.

However, at lunchtime Friday, equity markets have bounced back. And that's the rub here. There are still plenty of investors happy to buy the dips. Time to worry is when they disappear.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.