Are Indices Markets Looking Up?

Indices Markets

The FTSE 100 index is currently trading around the 7930 mark, with bullish momentum driving market activity. The premier UK index has a 52-week range of 7256.94 on the low end and 7930.92 on the high. While the 1-year rate of return is in negative territory (-0.17%), positive sentiment is rapidly closing the gap. Interestingly, multiple ETFs (exchange traded funds) tracking the FTSE 100 index such as ISF, L100, and VUKE reflect current the upbeat trends in the financial markets.

The Bank of England (BOE), like its counterparts, the Reserve Bank of Australia (RBA) and the Federal Reserve Bank (FED), is inching towards monetary easing. The Fed, in its March meeting, intimated that several rate cuts are expected to the Federal Funds Rate in 2024. Taking its cue from the world’s leading central bank, the BOE (based on domestic markets) is also moving towards ending higher interest rates. Currently, the bank rate is 5.25% in the UK, with an inflation rate of 3.4%. The BOE, like the Fed, is targeting an inflation rate of 2%.

Navigating through the intricacies of the stock market, indices trading on the FTSE 100 index remain a benchmark for the UK financial landscape. It encapsulates the performance of the country’s top-tier companies. As a critical indicator, it reflects the UK economy’s vitality, offering investors and analysts alike a comprehensive view of the market’s health through its meticulously calculated composition. Employing a market capitalization-weighted methodology, the FTSE 100 ensures that each constituent company is represented in proportion to its size, providing a balanced and nuanced perspective of the UKs corporate prowess.

Targeting Inflation

Andrew Bailey, the Governor of the Bank of England, last sent a letter to the Chancellor of the Exchequer, Jeremy Hunt, on March 21 2024, indicating that the CPI was 3.4% in February. The BOE, in tandem with the MPC (Monetary Policy Committee), is tasked with returning the inflation rate to the 2% mark. Whenever inflation moves 1% away from that target figure, official communications between the BOE and the Chancellor of the Exchequer are required. In the case of the UK, inflation peaked at 11.1% in October 2022, bringing tremendous pressure to be on the UK economy and impacting markets in an unprecedented way.

By Q2 2024, the BOE anticipates inflation to drop to the 2% target, rising slightly towards the end of the year. The complex interrelationships between inflation and stocks is directly associated with the purchasing power of money over time. As inflation rises, or is maintained, the real value of money declines. More importantly, for traders and investors, the interest paid on borrowed funds is higher during inflationary cycles. This diminishes real returns in the form of company profitability and dividends.

In the UK for example, inflation has a crippling effect on the purchasing power of households, as noted by the following comparative statics:

April 1991 pricesApril 2021 prices
A loaf of sliced white bread – 54p£1.08
An orange – 19p33p
£100 basket of merchandise£226
£100 worth of gold£617

For shares, the relationship is slightly tricky since equities are not priced according to a simple system. Generally, stocks are perceived as a hedge against inflationary pressures. We see evidence of this across UK markets, with indices trading, commodities trading, shares, and contrarian investment options. Increased input costs result in companies adjusting their prices and passing on additional costs to consumers. Naturally, it’s best to stick to value shares during inflationary cycles since they tend to outperform. These shares have a higher intrinsic value than the prevailing price.

Indices Markets Looking Up
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Conversely, lower inflation is associated with lower interest rates. It also means increased demand through expenditure. When companies post strong profits, demand for shares typically increases. This results in appreciation, which often translates into higher returns. Generally, lower interest rates result in higher disposable incomes and more spending. This should boost economic activity, business spending, and investment. Typically, this results in stronger ROE (return on equity) through share price appreciation and dividends. Investors are carefully eyeing the May 9, 2024, BOE announcement.

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