Three sectors to keep an eye on in 2018

After ending 2017 on a hot streak, with a string of consecutive closing record highs, the FTSE 100 stands above 7,600 and sits within barely 5% of the 8,000 mark.






FTSE 100 set a run of new all-time record highs at the turn of the year

FTSE 100

Source: Thomson Reuters Datastream

This naturally begs the question of whether this momentum can be maintained and if so why – and if not, then why not.

To get a better understanding of this it is necessary to look at the index’s make-up and which sectors and stocks wield the greatest influence, both in terms of their market capitalisation and their contribution to the benchmark’s aggregate profits and dividend payments.

This issue of mix will have a great say in how the FTSE 100 may perform in 2018 and beyond and investors really need to keep their eyes on just three groupings of stocks, as they dominate analysts’ consensus forecasts for profit and dividend growth. They are (in alphabetical order):

  • Consumer stocks (both discretionary and staples)
  • Financials (namely banks and insurance, both life and non-life)
  • Oil & Gas Producers

An aggregate of bottom-up analysts’ consensus forecasts shows that this trio is expected by analysts to generate roughly two-thirds of the index’s total profits and dividend payments in 2018.

More potently still these three sectors are forecast to provide nearly 90% of the forecast growth in earnings and almost 80% of the forecast growth in dividends.

For the moment, most of these sectors can be seen in a reasonably positive light.

The banks passed the Bank of England’s latest round of stress tests and profits could improve nicely if they can cut down on the fines and misconduct charges while any rise in bond yields should help the insurers. Meanwhile, rising crude prices are helping to reassure investors and fund managers that the dividends offered by the oil majors Shell and BP are relatively safe.

Of greater concern is the contribution from consumer staples and especially consumer discretionary. At least the forecast increase in earnings (and thus dividends) from the staples names rests heavily on British American Tobacco and Imperial Tobacco making the most of their recent acquisitions, as well as an improvement in the fortunes of the food retailers (which is less certain, given the ongoing assault they face from the discounters).

The anticipated increase in earnings from discretionary-spend-related stocks such as retailers, travel and leisure and media names is also open to debate, although any unexpected strength in the pound could help several stocks here, by dampening inflation, boosting consumers’ real spending power and making overseas holidays more affordable for good measure.

Looked at in these terms, the FTSE 100 may not be getting overheated after all, although a slide in oil prices, a weak pound and soggy bonds yields (in the event the Brexit talks or some other factor weighs on sentiment and the UK economy) could between them quickly unravel the promising picture. The FTSE 100 did underperform in 2017 for a reason, after all, as its mid-single digit percentage gain in capital terms paled next to the 20% advances seen in America and Japan and the 30%-plus surge witnessed in Asian stocks.

Feel the width

The earnings recovery currently forecast by analysts for 2018 once their bottom-up, company-by-company forecasts are aggregated does look reassuring. An 11.5% advance in pre-tax income to £216 billion is the current estimate and if that proves accurate then FTSE 100 earnings would advance beyond both the (oil and mining-fuelled) peak of 2011 and the £168 billion reached in 2007 just before the Great Financial Crisis.

FTSE 100 total profits are expected to increase again in 2018

FTSE 100 profits

Source: Digital Look, company accounts, consensus analysts’ estimates

If reached, this total would also exceed the £168 billion reached in 2007 just before the Great Financial Crisis by nearly 30%. Under such circumstances it is at least easier to argue that the FTSE 100 should be trading above the 6,732 peak reached in June 2007.

The projected dividend payout figure of £88.5 billion also represents another year-on-year advance, in this case one of around 7%, which should please income-seekers, especially as it leaves the index offering a prospective yield for 2018 of around 4.3%.

FTSE 100 total dividends are expected to increase again in 2018

FTSE 100 dividends

Source: Digital Look, company accounts, consensus analysts’ estimates

If there is anything to worry about, it is the lack of positive momentum in earnings and dividend forecasts. While the absence of the steady downgrades which dogged 2014, 2015 and 2016 is to be welcomed, the lack of upgrades could be an encumbrance as the FTSE 100 tries to weave its way toward 8,000.

FTSE 100 profit forecasts for 2017 are flat-lining ...

FTSE 100 profit flat-lining

Source: Digital Look, consensus analysts’ estimates

... as are analysts’ estimates for total dividend payments

FTSE 100 dividends flat-lining

Source: Digital Look, consensus analysts’ estimates

Friendly trend

This begs the question of the potential source of those all-important upgrades and this can be quickly assessed by looking at which industrial sectors dominate the prevailing forecasts.

To look at a static snapshot of the FTSE 100, this table shows which sectors are expected to make the largest contributions to sales, profits and dividends in 2018.

Banks and insurers (bracketed together in the ‘financials’ bucket), oils and consumer plays analysts to provide 63% of total profit and 64% of total dividend payments in 2018.

A handful of sectors dominate the FTSE 100’s profit and dividend forecasts for 2018

Forecast profit contribution Forecast dividend contribution
Financials 25% Financials 23%
Consumer Staples 15% Oil & Gas 20%
Oil & Gas 13% Consumer Staples 13%
Mining 13% Mining 8%
Consumer Discretionary 10% Health Care 8%
Industrial goods & services 8% Consumer Discretionary 8%
Health Care 8% Industrial goods & services 7%
Telecoms 3% Telecoms 6%
Utilities 3% Utilities 4%
Technology 1% Real estate 1%
Real estate 1% Technology 1%

Source: Digital Look, consensus analysts’ estimates

This trio’s influence looks all the more potent when their contribution to growth in earnings and dividends is assessed. In this case, they are forecast to provide 87% of the anticipated £22.3 billion increase in FTSE 100 pre-tax profits and 79% of the projected increase in dividends (where oil and gas is seen making a minimal contribution).

Three sectors dominate the FTSE 100’s profit and dividend growth forecasts for 2018

Forecast profit growth contribution Forecast dividend growth contribution
Consumer Staples 30% Financials 47%
Oil & Gas 29% Consumer Staples 16%
Financials 18% Consumer Discretionary 15%
Consumer Discretionary 10% Industrial goods & services 9%
Industrial goods & services 6% Mining 7%
Telecoms 3% Telecoms 2%
Technology 2% Utilities 1%
Utilities 2% Health Care 1%
Health Care 2% Technology 1%
Mining 0% Real estate 1%
Real estate 0% Oil & Gas 1%

Source: Digital Look, consensus analysts’ estimates

Fund selection

An investor who wants exposure to UK equities may feel handily served by a FTSE 100 tracker or exchange-traded fund, but they need to know what they are buying or relying upon – and in this case it is a select list of stocks and sectors, according to current profit and dividend forecasts.

Equally, anyone choosing an actively-managed fund will want to divine how the fund manager views these three sectors in particular. This can be done by looking at a fund’s weightings toward each one and getting them right will go a long way to determining whether a collective will outperform or underperform the UK’s benchmark indices in 2018 and beyond.

To help in this regard, we have adapted our usual fund performance tables to show the sector weightings of the top five performing UK equity ETFs over the past five years and top 10 performing large cap UK equity funds and investment trusts.

Note that in total the financials, oils and consumer sectors represent 64% of the FTSE 100 by market cap (breaking down as 22%, 14% and 28% respectively).

Best performing UK Large-Cap Blend Equity ETFs over the past five years

Exchange Traded Funds Market cap £m Annualised 5-year performance Dividend yield Total Expense Ratio Morningstar rating  Replication method Financials Weighting toward Consumer Oils
SPDR FTSE UK All-Share UCITS ETF 296.7 9.81% n/a 0.20% *** Physical 20.5% 27.2% 13.2%
db x-trackers FTSE All Share UCITS ETF (DR) 1D 70.4 9.61% 3.91% 0.20% *** Physical 20.7% 26.9% 13.5%
Lyxor FTSE All Share UCITS ETF 8.8 9.47% n/a 0.40% *** Synthetic 20.4% 27.3% 13.4%
iShares FTSE 100 UCITS ETF GBP (Acc) GBP 449.8 9.03% n/a 0.07% ** Physical 21.2% 27.4% 15.9%
db x-trackers FTSE 100 UCITS ETF DR (1C) 129.4 9.03% n/a 0.09% ** Physical 21.5% 27.2% 15.9%

Source: Morningstar, for UK Large-Cap Blend Equity category. Where more than one class of fund features only the best performer is listed.

Best performing UK Large-Cap Blend Equity OIECs over the past five years

Open-ended Investment Company Fund size £m Annualised 5-year performance  12-month Yield Ongoing charge  Morningstar rating  Financials Weighting toward Consumer Oils
Investec UK Alpha I (Acc) Net 1,828.8 14.00% 2.30% 0.84% ***** 15.3% 32.2% 8.1%
Majedie UK Focus X (Inc) 864.3 13.08% 1.66% 1.52% ***** 18.7% 24.7% 19.8%
RWC UK Focus A GBP 100.0 12.98% n/a 1.85% ***** 28.5% 21.7% 15.3%
BNY Mellon-Newton UK Opportunities Institutional W (Acc) 427.8 12.74% 1.97% 0.80% ***** 14.6% 27.6% 11.0%
Threadneedle UK Select Z (Inc) GBP 450.6 12.61% 2.43% 0.88% **** 33.2% 32.5% 8.5%

Source: Morningstar, for UK Large-Cap Blend Equity category. Where more than one class of fund features only the best performer is listed.

Best-performing UK equity investment companies over the last five years

Investment company Market cap £m Annualised 5-year performance*  Dividend Yield Ongoing charges**  Discount to NAV Gearing Morningstar rating Financials Weighting toward Consumer Oils
JP Morgan Mid Cap 285.3 23.0% 1.9% 0.86% -6.8% 6% *** 20.1% 24.9% 0.8%
Henderson Opportunities 85.8 19.5% 1.9% 0.94% -16.5% 15% ** 7.9% 24.0% 6.3%
Fidelity Special Values 673.6 18.1% 1.8% 1.06% -5.3% 11% **** 26.3% 19.8% 4.3%
Mercantile 1,775.0 17.4% 2.3% 0.50% -8.9% 2% **** 19.5% 27.6% 0.4%
Schroder UK Mid Cap 199.1 16.1% 2.4% 0.93% -15.9% 0% **** 17.1% 30.8% 0.7%

Source: Morningstar, the Association of Investment Companies, for the UK All Companies category.
* Share price. ** Includes performance fee

Russ Mould, AJ Bell Investment Director