The FTSE 100 could fall 15 per cent by the end of 2019 as supportive tailwinds become headwinds blocking any further advance for the blue-chip index, according to consultancy Capital Economics.
Chief markets economist John Higgins said he was forecasting the large-cap benchmark to fall to 6,500, or around 15 per cent lower than current levels of around 7,600-7,700.
It follows a recent purple patch for the UK blue-chip index after a challenging start to the year.
The FTSE 100 fell by 11.44 per cent between 12 January and 26 March, according to data from FE Analytics. However, the large-cap index has since rebounded and is marginally up by 0.46 per cent during 2018 overall.
Performance of FTSE 100 YTD
Source: FE Analytics
The index has risen by 25.61 per cent since the EU referendum in the summer of 2016. Its lower growth compared with other developed markets – the S&P 500 has risen by 33.88 per cent during the same period – has been attributed to uncertainty surrounding Brexit.
However, the index consists of a number of large international companies paying strong dividends with little direct exposure to the UK economy and as such has remained popular with some yield-hungry investors.
Given the greater international focus of many of its constituents, the FTSE 100 has been a beneficiary of the general weakening of sterling since the referendum and more recently.
“A key reason why the FTSE 100 has risen by more than 6 per cent since mid-April has been the slide in sterling against the dollar, from nearly $1.44/£ to about $1.35/£,” said Higgins.
“This has not only boosted the competitiveness of UK multinationals’ exports, but also raised the sterling value of their foreign subsidiaries’ earnings.”
Indeed, Capital Economics’ Higgins noted that the relationship between the dollar/sterling exchange rate and the relative performance of the FTSE 100 and S&P 500 “tends to be quite strong”.
“This helps to explain why the UK index has fared so well over the past month, even though its US counterpart has barely risen during this time,” he explained.
Sterling weakened further last week following the decision by the Bank of England’s Monetary Policy Committee to leave the base rate unchanged.
Many economists and analysts had been expecting the first rise in interest rates since last November, when the post-referendum cut was reversed.
Yet, low inflation and weaker-than-expected growth during the first quarter saw the policymakers hold back on making any changes at the May meeting.
The FTSE 100 has been supported by the strengthening oil sector, which has rebounded following a difficult period for producers.
Performance of Bloomberg Brent Crude Sub vs FTSE 100 over one month
Source: FE Analytics
Oil prices fell as global growth slowed and the emergence of the US shale oil industry increased supply and drove prices lower. However, oil has strengthened more recently as growth has picked up. Prices have also risen in recent weeks as US president Donald Trump withdrew his country from the Joint Comprehensive Plan of Action, which sought to the curtail nuclear weapon programme of Iran – a significant oil producer – in exchange for the lifting of sanctions against the country.
The FTSE 100 has benefited thanks to its large weighting to the sector, with oil giants BP and Royal Dutch Shell representing 16.40 per cent of the index.
Higgins said the representation of oil in the index was much greater than the S&P 500, where the energy sector accounts for just 6 per cent of market capitalisation.
The Capital Economics economist said since mid-April the energy sector has risen by around 13 per cent in the MSCI UK index, which closely tracks the FTSE 100, compared with just 5 per cent for the same sector in the MSCI USA, which follows the S&P 500 more closely.
However, Higgins said while these two tailwinds have driven the FTSE 100 more recently, it was unlikely that they would continue to support the blue-chip index over the long term.
One major reason is the outlook for monetary policy, he said, noting that the dollar has appreciated against all major currencies since mid-April but has strengthened most against sterling.
He noted that first-quarter growth had been negatively impacted by bad weather in March, making the deferral of a rate hike by the Bank of England temporary.
“In our view, economic growth will surprise on the upside in the future, prompting the Monetary Policy Committee to tighten policy by more than investors are currently envisaging,” said the Capital Economics chief markets economist.
Higgins said the dollar could benefit from tighter Federal Reserve policy, but that the consultancy expected the central bank to raise rates by more than what many investors are discounting in the coming year.
He noted: “We suspect that rates will stop rising after that and start falling again in 2020 as the Fed responds to a sharp slowdown in the US economy.
“This prospect will probably start to weigh on the dollar against the pound.”
Additionally, Higgins said that the boost to the FTSE 100 from rising oil prices was likely to become a drag on performance.
The consultancy is currently forecasting prices for Brent crude will fall from current levels of around $77 per barrel to $65 per barrel by the end of year.
Performance of indices YTD
Source: FE Analytics
“If we are right about the prospects for sterling and oil, then the FTSE 100 is unlikely to outperform the S&P 500 despite having a higher share of ‘defensive’ sectors than its US counterpart,” said Higgins.
“And our forecast is that the S&P 500 will also fall sharply next year, to 2,300, as the US economy cools.”