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

After ending 2017 on a hot streak the FTSE 100 is finding the going tougher in 2018 and 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.

Spring rally leaves FTSE 100 near its all-time highs

Source: Thomson Reuters Datastream

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 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 advisers and clients really need to keep their eyes on just four groupings of stocks, as they dominate analysts’ consensus forecasts for profits and profit growth, as they are the most likely drivers of capital returns. They are (in alphabetical order):

  • Financials (namely banks and insurance, both life and non-life)
  • Healthcare
  • Miners (whose profit contribution is relatively modest but whose rapid rebound means it is forecast to provide a big chunk of profits growth)
  • Oil and gas producers

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

Four sectors dominate FTSE 100 earnings and profits growth forecasts in 2018

Source: Digital Look, company accounts, aggregate consensus analysts’ forecasts

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 and Shell’s 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 upgrades, at least when it comes to industrial metals and coal (as gold and silver prices seem largely becalmed for the moment, with copper barging through the $7,000 a ton 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 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 that advisers and clients remain sceptical of bullish profit forecasts which call for the lenders to make more money in aggregate in 2018 (£36.3 billion, before tax) than they did during the go-go, boom years of 2006 and 2007.
  • Questions to answer – pharmaceuticals/healthcare. In theory, the pharmaceuticals/healthcare combination is due to almost double its pre-tax profits to £16 billion in 2018, generating almost a seventh of total FTSE 100 earnings growth for the year. Yet much of the estimated uptick is due to come from AstraZeneca and GlaxoSmithKline and is as much to do with lower exceptional charges and restructuring costs as it with new drug releases and powerful pipelines. The problem is we have 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.

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

FTSE 100 earnings estimates are moving higher again

Source: Digital Look, company accounts, aggregate consensus analysts’ forecasts

At least advisers and clients 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, while 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.

FTSE 100 earnings are seen reaching record levels in 2018

Source: Digital Look, company accounts, aggregate consensus analysts’ forecasts

AJ Bell Investment Director

Russ Mould’s long experience of the capital markets began in 1991 when he became a Fund Manager at a leading provider of life insurance, pensions and asset management services. In 1993 he joined a prestigious investment bank, working as an Equity Analyst covering the technology sector for 12 years. Russ eventually joined Shares magazine in November 2005 as Technology Correspondent and became Editor of the magazine in July 2008. Following the acquisition of Shares' parent company, MSM Media, by AJ Bell Group, he was appointed as AJ Bell’s Investment Director in summer 2013.