FTSE 100 weakness 'unlikely' to signal wider UK economic decline

A 4% fall in the FTSE 100 in the last fortnight, including a six-week low early on Monday, has prompted economists to ponder whether this weakness heralds a new softness to the UK economy.

Since reaching an all-time peak in April 2015, London's blue chip index has lost nearly 15% - the same fall that predated the 2008 financial crisis.

British blue chips have exceeded the declines in the main US, European and Japanese markets, with an underperformance that was first born in early 2014.

The index has fallen by 10% since then, noted economist Sam Tombs at Pantheon Economics, compared to rises of between 10% and 20% in the main overseas benchmarks.

Tombs also conceded some negative effect of the blue chip index's decline on the economy, such as if the fall in equity prices persuades companies to buy back their equity rather than undertake capital spending.

"A bigger risk is that the reduction in the value of households’ financial assets caused by the fall in stock prices causes them to tighten their purse strings."

But he dismissed a connection with the wider economy as the FTSE 100 has historically proved a poor leading indicator of recessions, pointing out that the index has fallen by 15% or more over a six-month period on five previous occasions since 1980: "only once — 2008 — did this signal a recession".

"We doubt, however, that the collapse in UK equity prices signals impending economic misery," Tombs reassured, partly as its constituent companies are not a fair reflection of the sector composition of the UK economy.

"Much of the relative performance of the FTSE 100 compared to the S&P 500 appears to be explained by movements in oil prices. Oil, natural resource and financial services companies account for 13%, 5% and 14% of the index respectively. But these sectors account for just 1.5%, 0.5% and 8% of GDP."

"Lower oil prices, while bad for the stock market, have been a net positive for the UK economy, since it is now a net consumer of oil."

The Footsie's softness also reflects sterling’s appreciation, which is a by-product of the strength of the UK’s slow economic recovery.

"About 75% of the profits of FTSE 100 companies are derived from overseas activities, so a stronger pound greatly reduces the sterling value of their earnings," he added, while the more UK-representative FTSE 250 has performed much better than its big sister over the last two years.