Could a strong finish be in sight for FTSE 100 in 2023?

THE FTSE 100 Index Futures contract, colloquially known as “Footsie”, encapsulates the top 100 largest publicly-traded companies on the London Stock Exchange by market capitalisation. The UK stock market has faced a tough year, with the cash index posting a 0.50 per cent year-to-date (YTD) decline as at the market close on Oct 25. This decline extends the equity slump that began with the Brexit referendum in 2016. What is particularly intriguing is that the index actually outperformed its European counterparts in September, boasting a 2.27 per cent gain in contrast to a 3.51 per cent decline in Germany’s DAX and a 2.48 per cent drop in France’s CAC 40 Index. This outperformance can be largely attributed to a recent surge in oil prices, which has historically benefited the export-heavy FTSE 100.

Hence, despite the challenges and slump in the index, we hold a bullish outlook on the UK stock market, and see further upside potential in the FTSE 100 Index Futures contract due to attractive valuations and robust dividend yields, favourable sector composition and rising oil prices, and lastly sensitivity to a weaker Pound.

On a fundamental perspective, the FTSE 100 Index currently offers an attractive valuation compared to other regions, and it boasts one of the highest dividends yields among developed markets. The Footsie currently trades at a price-to-earnings (PE) ratio of 10.9x for the last twelve months, a 25 per cent discount to its five-year average PE ratio of 14.5x. Furthermore, it is trading at a 47 per cent discount in comparison to the S&P 500. The index also has a dividend yield of 3.97 per cent as of Q3, well above the 1.61 per cent yield offered by the S&P 500.

The Footsie’s sector composition further supports our bullish outlook, as the index has a larger emphasis on the energy sector compared to its counterparts. Specifically, 14.8 per cent of the FTSE 100 Index consists of companies in the energy sector, including blue chip oil majors such as Shell and BP. In comparison, the energy sector constitutes only 4.8 per cent of the S&P 500 and 5.5 per cent of the STOXX 600. Hence, we see rising oil prices serving as a tailwind for the FTSE 100, especially in the context of Opec+ production cuts and high geopolitical risks.

Finally, it is worth noting that the FTSE 100 Index’s sensitivity to fluctuations in the British pound (GBP) also further reinforces our positive outlook. This is crucial as around 70 per cent to 75 per cent of FTSE 100 constituents’ revenue is generated from foreign countries in various currencies. Hence, a weaker pound typically translates into higher profits for companies when they convert their overseas earnings back to the local currency. According to Bloomberg, the FTSE 100 has a strong inverse correlation of 0.63 with the GBP/USD currency pair since 2010. Furthermore, the Bank of England’s recent policy pause, slowing inflation, and a weakening economy should continue to put the pound on the back foot, benefiting UK exporters.

On the technical front, following an uptrend since mid-October, the FTSE 100 Index Futures contract has been consolidating within a symmetrical triangle pattern. It recently broke out below the trend line support, before retracing and closing back above the support zone forming what seems like a false breakout. Some other key observations supporting our bullish thesis are:

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• The Relative Strength Index (RSI) indicator is currently hovering around 38 and is nearing the oversold level of 30, which typically serves as a bullish reversal signal.
• The 50-day moving average appears to have barely crossed over the 100-day moving average. In general, whenever a shorter-term moving average cross over a longer-term moving average, it is considered a bullish signal.
• A false breakout pin bar, as well as multiple preceding false breakouts to the downside, may signal a failure to sustain bearish momentum and hint at a potential trend reversal to the opposite direction. This reversal might target the trend line resistance of the symmetrical triangle pattern, located at the 23.6 per cent Fibonacci retracement level around 7,700-7,711.

In summary, we maintain a bullish outlook on the UK stock market and foresee the FTSE 100 Index Futures contract reaching the 23.6 per cent Fibonacci retracement level around 7,700-7,711 by the close of 2023. If this level is broken, we see the Footsie sustaining its bullish momentum and climbing further upwards to psychological resistance at 7,800.

The writer is an investment analyst at Phillip Nova