Oils and banks remain the key to FTSE 100’s momentum

Pharma/healthcare and miners are also important to the direction of the blue chip UK stock market index  
Thursday 21 Jun 2018 Author: Russ Mould

After ending 2017 on a hot streak the FTSE 100 is finding the going tougher in 2018. Although it stands within touching distance of the all-time high reached in May, the benchmark index can point to a capital return of barely 1% as the first half of this year draws to a close.

This naturally begs the question of whether the index can find fresh momentum in the second half and if so why – and if not, then why not?

To get a better understanding of this situation 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.

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This issue of mix will have a great say in how the FTSE 100 may perform in 2018 and beyond. Investors need to keep their eyes on just four groupings of stocks, as they dominate analysts’ consensus forecasts for profits and profit growth, and they are the most likely drivers of capital returns. They are (in alphabetical order):

- Financials (namely banks and insurance, both life and non-life)

- Pharmaceuticals/Healthcare 

- Miners (whose profit contribution is relatively modest but whose rapid rebound means the sector is forecast to provide a big chunk of profit growth)

- Oil and Gas Producers

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An aggregate of bottom-up analyst consensus forecasts shows this quartet is expected to generate roughly two-thirds of the index’s total profit and three-quarters of its profit growth this year.

FOUR AGAINST THE FIELD

For the moment, two of these sectors can be seen in a positive light, although one is now facing greater challenges. One seems set fair but has yet to convince, judging by recent share price performance, while one has been a perennial disappointment of late.

- Going well – Oils and miners

The big oil stocks have understandably been boosted by a surge in the oil price to $80 as OPEC and Russia have surprised many by sticking to the production cuts first outlined in December 2016.

The question now is whether Saudi Arabia and Russia start to push for higher output now, to the potential detriment of the oil price and BP (BP.) and Royal Dutch Shell’s (RDSB) earnings momentum, although income hunters will be pleased to see how a higher crude price means their dividend payments are better underpinned.

The miners continue to see earnings upgrades, at least when it comes to industrial metals and coal. Gold and silver prices seem largely becalmed for the moment, with copper barging through the $7,000 per tonne mark, helped by talk of strikes in Chile in particular.

Whether their highly cyclical revenue streams can be entirely relied upon is open to question but if the market narrative of a ‘synchronous global upturn’ holds good, then the UK stock market could benefit from its exposure to miners.

- Could be doing better: the banks

This is an odd one. In theory, conditions look primed for better performance from the banks, as equity markets rise, merger and acquisition activity booms, debt and mortgage delinquencies remain low, regulatory woes start to fade into the background and the lenders reap the benefits of their cost-cutting programmes.

Yet the sector worldwide is struggling and the UK’s Big Five have lost share price momentum to suggest investors remain sceptical of bullish profit forecasts.

- Pharma: questions to answer

In theory, the pharmaceuticals/healthcare combination is due to almost double its pre-tax 

profit to £16bn in 2018, generating almost one seventh of total FTSE 100 earnings growth for the year.

Yet much of the estimated uptick is due to come from AstraZeneca (AZN) and GlaxoSmithKline (GSK) and is as much to do with lower exceptional charges and restructuring costs as with new drug releases and powerful pipelines. We’ve heard this story before and neither firm has delivered so far.

FEEL THE WIDTH

For all of such doubts, the good news is that aggregate earnings forecasts for the FTSE 100 are rising again, as the pound weakens (thanks to the Bank of England), oil and metal prices point to gains on the year, and companies with US exposure have begun to see the benefits of the Trump tax cuts.

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This absence of net profit downgrades compares favourably to 2014, 2015, 2016 and also 2017 right at the end.

At least investors now know which sectors need to do the business to keep that trend going. If oils, miners, banks and healthcare stocks find trouble, then the FTSE 100 may well do the same.

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Further commodity price gains, a clean regulatory bill of health for the banks and improved earnings from the big drug plays could herald that long-awaited push to 8,000 and beyond.

By Russ Mould, investment director, AJ Bell

 

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