FTSE 100 Gains From Risk Appetite But Relies Heavily on Certain Sectors

The UK benchmark index continues setting new highs, but its dependence on certain sectors may limit future gains.

Risk Appetite Grows

Risk appetite among investors has increased over the last month. The FTSE has been one of the top-performing indices during this time as investors have become more willing to take on risk. While it has pulled back slightly from last week's new all-time high, the market is viewed as having strong further upside potential since it is considered undervalued relative to its history. Brexit and interest rate hikes by the BOE had previously reduced investor demand for UK stocks, leading to lower valuations, especially in the banking sector. This trend now seems to be reversing.

However, factors beyond just the UK and the BOE's potential easing policy have also contributed to the gains, though they do not fully explain the move higher. As one of the most internationally focused indices, much of the FTSE 100's weighting comes from global markets. This often allows the index to avoid some domestic turbulence but also makes it subject to international trends. Going forward, most central banks are broadly expected to pursue easier monetary policies. While the timing may be debated, there is general agreement that interest rates will be lower not just in the UK but also in the US, Europe, and Canada by the end of this year and will continue lower into 2025. This outlook understandably supports higher stock prices.

Potential Headwinds

A few events could impact the positive outlook for the FTSE index. In addition to some smaller issues like an upcoming general election in the UK, where Labor currently leads in polls, the index is highly dependent on exports. Oil majors BP and Shell make up a large portion of the index's weighting and recent gains. However, oil prices are currently high due to geopolitical tensions, which could be resolved going forward. This may mean that one of the leading drivers for the FTSE could turn into a drag.

Banks, which have risen as investors realise UK financial houses were generally undervalued, particularly in light of bank collapses in Europe and the US last year, also present a risk. Typically, lower interest rates provide a challenging environment for banks to generate profits, which could dampen their performance. There is also potential risk from central banks needing to cut rates significantly, given the unresolved question of whether a global recession is imminent. The market seems to have priced in hopes that no "landing" will occur, with forecasts of continued economic growth in the UK, EU and US. If this holds true, the bullish outlook for the FTSE may prove correct.

FTSE Shy of Target

Should the measured move methods be used, the FTSE's recent breakout to new highs suggests further potential upside to around 8550 following a triangle breakout. A move past that could see prices target the 161.8% Fibonacci expansion level of 8870. In contrast, only a break below 8045 and 7690 would significantly reduce the likelihood of continued advances in the short term, with nearer-term support residing at 8260.

Source: SpreadEx / UK 100

Key Takeaways

The UK benchmark index continues setting new highs, driven by strong gains in oil majors and banks as investors take on more risk. However, its dependence on certain sectors, like oil and financials, could limit future upside should geopolitical or economic conditions change in ways that impact those industries.