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Victoria Scholar of Interactive Investor explains why the FTSE 250 could outperform the FTSE 100 in 2023
Victoria Scholar is head of investment at Interactive Investor.
Last year was undeniably difficult for investors, with stock markets suffering from a cocktail of macroeconomic headwinds and the war in Ukraine.
The FTSE 100, an index of the biggest 100 companies listed in London, however, proved to be remarkably resilient, rising 0.9 per cent in 2022. In contrast, the FTSE 250, which hosts the biggest 250 companies below the top 100, fell by nearly 20 per cent.
The UK large-cap index is an outward-looking group of stocks including many international companies, driven by global economic forces, whereas the mid-cap index is more domestically oriented, making it more correlated to the health of the UK economy and developments in Westminster.
In 2022 the FTSE 100 saw a big impact from the war in Ukraine. Within the index, a jump in defence spending provided a tailwind for shares and earnings at BAE Systems, an arms manufacturing business.
The ongoing conflict between Russia and Ukraine also sent commodity prices soaring, helping BP and Shell to record sky-high profits and British Gas’ parent company, Centrica experienced a sharp jump in earnings on the back of soaring energy bills.
The commodity boom also supported stocks in the mining sector, such as Glencore and Antofagasta, which logged stellar stock market returns in 2022.
>> What will 2023 bring for investors? The hope of easing inflation, an end to rate hikes, and a shallow recession for the UK
Pent-up demand for goods and services, problems with the global supply chain post-pandemic and the Ukraine war sparked inflation which topped a 41-year high last year.
The Bank of England has been attempting to offset this by raising rates over the past 14 months, playing into the hands of financial stocks like Standard Chartered which can charge higher rates on loans.
Last year, the FTSE 250 battled against the UK’s economic deterioration, as inflation accelerated and growth slowed.
Plus, the political turmoil around the disastrous mini-Budget and the revolving door at Downing Street added to the sense of uncertainty, prompting international investors to shift away from UK companies.
In addition, the fallout from the cost-of-living crisis has meant that domestic consumption has softened, creating pain for stocks like Dr. Martens and Aston Martin within the index.
Shift away from pandemic trends
Looking back at the pandemic, e-commerce businesses boomed, while bricks and mortar stores were forced to close.
However, in 2022 we saw a decisive shift as online shopping faded, weighing on other FTSE 250 stocks like Asos and Moonpig.
International Distribution Services, which is the parent company of Royal Mail, had additional problems of its own, as industrial action caused widespread disruption and wiped out its profits.
But is the playing field starting to even out between the two indices? Both the FTSE 100 and FTSE 250 have enjoyed a strong start to 2023 thanks to a pick-up in market sentiment, with the mid-cap index so far in the lead in terms of percentage gains.
Political uncertainty has eased while expectations are that the UK could narrowly stave off a recession, an improving picture versus last year’s rather gloomy forecasts.
Plus, the Bank of England appears to be shifting towards less aggressive rate hikes. These factors, when combined with the revival of the opportunistic investor pouncing on beaten up stocks, could provide a tailwind for the FTSE 250 this year.
Looking ahead, easing oil and gas prices and new windfall taxes could remove last year’s support for the commodity giants of the FTSE 100, while the prospect of a potential rate cut by year-end from the Bank of England may dampen the prospects for British lenders.
Sterling is important to keep an eye on, too. Last year’s US dollar appreciation caused the pound to suffer, whereas that currency trend appears to be reversing now. A stronger sterling can create issues for the FTSE 100, because its international companies make a large proportion of profits in dollars, which, when converted back into pounds, would be worth less.
However, UK housebuilders on the FTSE 100 have got off to a flying start in 2023 with Taylor Wimpey and Persimmon both up by more than 10 per cent since the start of the year as we approach the peak for interest rates.
Another key development to watch is China’s long overdue economic reopening, which is already providing support for FTSE 100 China-focused stocks like Prudential and Burberry.
Overall, we are not necessarily out of the woods just yet, but we are likely to see less disparity between the two UK indices.
2023 will be a bumpy ride amid tough macroeconomic conditions, but there are growing opportunities for investors in both indices, with the potential for the FTSE 250 to lead the way.
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