The FTSE 100 index is impacted by monetary policy, geopolitical factors and issues affecting specific firms and industry sectors. A basic understanding of these different factors can go a long way towards anticipating bullish or bearish sentiment. So what are the factors currently influencing the level and volatility of the FTSE?
1. Earnings reports
Stock valuations are driven by earnings expectations and the relation between consensus forecasts and actual figures, forward guidance and leading economic performance data. A positive or negative earnings surprise can have a dramatic effect on the price of a stock, and therefore the performance of an index. Recall that major stocks are assigned large weightings on indices like the FTSE 100. Individual stocks like HSBC, Royal Dutch Shell and GlaxoSmithKline have the capacity to drag the index lower or higher.
2. Interest rates
An inverse relationship exists between interest rates and investment levels in equities. When interest rates rise, the level of investment in FTSE 100 component shares declines because higher rates result in decreased corporate profitability owing to higher interest repayments. Higher interest rates result in increased debt and decreased profits, and are therefore associated with decreased investment in stock markets.
3. Changes to specific industry sectors
When bearish signals pervade the economy in specific industry sectors, they drag the index lower, and vice versa. For instance, the recent oil price woes had a deflationary effect on the UK economy, and oil-related sectors (e.g. mining, construction, oil producers) were dragged lower. Now that oil prices are trading in the $45–$50 per barrel range, oil-related stocks have been able to appreciate.
4. The Brexit referendum
On Thursday 23 June 2016, Britons will vote on whether to remain part of the European Union. This historic vote has far-reaching implications for the political, social and economic well-being of the UK and the EU. A vote for a Brexit would be expected to result in weakness for the FTSE 100, the pound, the euro, and European bourses. A vote to leave could (according to the chancellor of the exchequer and the head of the IMF) cause the UK housing market to crash, interest rates to rise and inflation to spiral out of control. A remain-vote by contrast would likely see a brief rally on the FTSE, followed by a return to the status quo. Anxiety has already been factored into the current level of the FTSE and the needle will move slightly as we head towards June 23.
5. The Bank of England’s quarterly inflation report
The inflation report has far-reaching implications for the FTSE 100, as it indicates the Bank of England’s current policy on interest rates. If inflation targets are being met, it is more likely that an interest rate hike will come to pass. If not, there is less justification for a rise. The Bank of England has a pre-stated 2% inflation target for 2016 and, with oil prices rising, it will be easier to achieve this target and justify a rate hike. As mentioned above, a rate hike would be expected to impact on the FTSE 100 in a negative way, at least in the short term.
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