Are you excited at seeing the FTSE 100 climbing back over 7,000 points, having been barely ahead of 6,000 just a few short months ago? Do you think that says our top companies are even better after the Brexit vote?
Well, no, it doesn’t suggest anything of the sort, and here’s why. The value of the FTSE is based on the market capitalisations of its constituents in sterling, suitably weighted and indexed to provide a manageable number. And sterling has fallen.
When the value of the pound falls, what happens to the price of gold? Assuming the global price in dollars remains the same, it’ll cost more pounds per ounce. The same goes for a barrel of oil, a tonne of iron ore…
FTSE 100 shares are global commodities too. And though the London Stock Exchange indices are geared to sterling, investors value the shares on the international stage and not here on these inward-looking isles. So when the pound falls, the price of a share in pounds should rise along with everything else.
It’s fallen!
The FTSE 100 has indeed risen by 12% since we learned the result of the EU vote, but the pound has fallen 15% against the dollar — so in dollar terms, UK shares have actually fallen in value.
You might say the international value of shares is unimportant, and all that matters is that if you sell some now you’ll actually get more pounds for them and you’ll have more to spend.
That’s true in the short term, but over the longer term prices even out through changes in inflation, and a FTSE rise simply through the falling value of sterling won’t get you any sustainable increase in the value of your retirement funds.
Don’t panic
So no, the uncertainties over our decision to leave the EU haven’t been overcome, our companies haven’t shrugged off the possible effects, and everything in the garden isn’t rosy — there’s still a lot of risk ahead, and we’re heading for a rockier few years than if we’d remained in the EU.
But while there’s no reason to get excited over the FTSE’s rise, there’s no reason for gloom and despondency either. That’s because our top companies are well placed to survive the short-term gyrations, and while some of them will surely be hurt by our European about-turn, the long-term future for the FTSE is still very solid.
Look at Royal Dutch Shell, our biggest London-listed company, and its forecast 7% dividends. Does the level of the FTSE, the value of sterling, or the UK’s exit from the EU make any difference to Shell? Not really — it’s an international company that’s way bigger than any of those things in the long term.
What about HSBC Holdings, the second biggest? HSBC suffered from the Chinese slowdown as China is what drives its business, but now things are reversed its shares are performing nicely, and the UK’s parochial worries are of nothing.
The same’s true if we look to GlaxoSmithKline, Diageo, Unilever… they’re still the same global companies they always were, and the arbitrary value of the FTSE counts for nought.