Why has the FTSE 100 index fallen below 7,000?

As I write Friday, with one hour left for the trading day to end, the FTSE 100 index is trading at just a shade below 7,000. It looks all set to close at such subdued levels for the first time in almost two months!

A broad FTSE 100 decline

It is clear though, that this is not a single day’s fall. The index has been weak-ish through the month so far. On average, there is no increase in the index from June. The fact that for the four months before this, the index average has risen every month puts this into context. The situation can reverse itself before the month is over. But for now, there is index weakness.

A sub-trend that is becoming glaringly obvious is that cyclical stocks are falling. From banks to miners and retail to real estate, this trend is increasingly clear.

Besides stock rotation, which I spoke of in the context of Cineworld earlier this week, I also think there is a perfect storm of sector specific reasons for this.

The China factor

Miners, for instance, are likely to be impacted by slower than expected Chinese growth. Demand from the economy has driven up industrial metals’ prices, favourably impacting mining stocks. But if demand does not pick up elsewhere in the world, the party looks like it is slowing down.

Stamp duty holiday rolls back

Things could slow down for FTSE 100 real estate biggies too. From 1 July, the stamp duty holiday has been rolled back for a house price of up to ￡500,000 to ￡250,000. This can impact demand for homes, even though for now these companies look well placed. I think a robust economy can stave off any severe effects on the housing market, but the UK’s economy has not taken off so far either. 

A relatively weak economy is bad news for banks too. Demand for loan is dependent on the state of the economy as well as on its outlook, but if it stays weak banks can suffer from lower demand. In fact, banks can also face the double blow of high inflation. 

Rising inflation

Inflation has been above the central bank’s comfort level of 2% for the past two readings. And this is hardly just a UK-specific phenomenon. The US too is witnessing high inflation, raising questions as to whether interest rates are likely to rise globally soon, spooking investors.

High inflation is also affects consumer spending, and in turn, the likes of retail. Not only do costs rise, but if they are passed on, consumers are likely to buy less as well. Further, higher inflation in general means that the same income level can buy less goods and services. So, consumers could get more choosy about their purchases. 

What can happen next

There is hope, though. As freedom day beckons, we may see a sharp upturn in growth. Policy makers believe that inflation may be transitory. It may turn out to be a storm in a teacup. Who knows? But if I am worried about inflation in particular, here is how I would invest.