The FTSE 100 breaks 7,000 again — further gains to come?

The FTSE 100 has finally broken through 7,000 once again and at the time of writing the UK’s leading index is only 30 points off its all-time record high of 7,104.  In the year-to-date the FTSE 100 is up by a staggering 13.3%, excluding dividends, outperforming the S&P 500 and EuroStoxx 50 by approximately 19% and 18.6% respectively. Since the end of June the index has gained 8.4%.

Time to celebrate? 

These gains may look impressive at first glance, but it’s not the time to uncork the champagne just yet. Most of the FTSE 100’s gains this year have come as a result of sterling’s devaluation, not from earnings growth or improving investor sentiment. Indeed, in dollar terms, the FTSE 100 is down by 2% year-to-date, which means that on a currency neutral basis the UK’s leading index is under-performing the more international S&P 500 by around 8%, although it is still outperforming the EuroStoxx 50, which is down by 5% in dollar terms, year-to-date.

Still, for UK investors the FTSE 100’s recent performance is something to celebrate. For the UK’s leading blue chips, which generate the majority of their income outside the country, a weaker pound will translate into higher profits. The market will reward higher profits by pushing share prices higher. 

For example, at the end of last week, Imperial Brands informed shareholders that weaker sterling would boost the company’s full-year profits by 4% to 5%. At the end of July, alongside half-year results, GlaxoSmithKline revealed that if sterling remained depressed throughout the rest of 2016, the currency effect could boost its earnings by as much as 19%. 

Commodity companies are also set to benefit greatly from sterling’s devaluation. Oil groups BP and Shell, in particular, will see a huge boost to earnings thanks to weaker sterling. Since the end of April, Brent crude traded in pounds has risen by 41%. Whilst this doesn’t mean BP and Shell’s earnings will jump by 41%, it does show how significant a weaker pound is for the UK’s leading companies.

What’s more, as companies reap these windfall profits from a weaker currency, shareholders could be in line for a special dividend bonanza.

The future is uncertain 

If the value of sterling continues to slide, the FTSE 100 could easily break through its all-time high. On the other hand, if sterling begins to strengthen, the FTSE 100’s recent gains could easily evaporate. This happened at the beginning of September, when sterling rallied against the dollar by 2% to 3%, and the FTSE 100 dropped from a peak of 6,900 to 6,670 in less than a week ,showing how difficult it is to try and predict the market’s future movement with any degree of confidence. 

Here at the Motley Fool, we believe that market timing or trying to second guess where the market is going is a waste of time and money, and  several academic studies have shown this to be true.