Why you should know your index

The FTSE 100 has been a relative underperformer because of its high weighting in financial and commodity companies. The indices that have outperformed have businesses that look to the future.

| 4 min read

The last few years have seen wide divergence in the performance of different international equity indices. Over the last five years, Nasdaq – the world’s second largest equity market – has more than trebled in value. Over the same time period, the German Dax is up by a half, the Shanghai share index is up 28% and the UK FTSE 100 just 13%. In contrast, the Japanese Nikkei 225 is now up by 90%.

One of the big differences rests in the sector composition of each index. These five years have seen a big advance by shares of companies involved in the digital revolution. This strong trend was propelled into overdrive by the impact of the anti-Covid-19 policies pursued by most governments. The more people stayed at home to work, shop and to be entertained, the more the digital giants captured their spending power.

Amazon’s cash flow and profits waxed as traditional retailers waned. Microsoft pocketed more consumer money as people turned to more home devices to stay in touch. The social media companies took much of the advertising spend away from traditional media.

Tech makes Nasdaq a winner

Almost half of the Nasdaq index is technology. Very little of either the FTSE 100 or the Shanghai index is in this important sector. The Chinese Index is dominated by financials and industry. The UK 100 index has higher weightings in energy and mining as well as financials.

The Nikkei 225 Japanese Index changes its constituent companies every year as the shape of the economy changes. It has a higher proportion in technology and communications as a result, though many still see it as an industrial economy in a digital age. Japanese companies comprise around one fifth of the world Robotics index, second only to the US which has half. Japan is advancing in artificial intelligence, intelligent machinery, telecommunications, and the rest.

In this part of the cycle, when people are looking forward to a recovery based on relaxing the lockdowns, there should be some balancing up of these extreme divergencies. Investors will find some value in the areas that did badly from lockdown and will think of taking some profits from the extreme gains they have made on the very successful technology groups.

Investors need to be aware that some of the shift in activity from in person to virtual is going to stick and some of the moves to more online shopping and working will remain. The green revolution will also carry on. Whilst fossil-fuel energy companies will get some benefit from the rally in oil and gas prices the recovery is bringing, the longer-term outlook is still poor as governments insist on moves to net-zero emissions.

Within the green movement there are debates about how to handle the transition for the more challenging areas such as large trucks, container ships and planes where there are no easy electric alternatives. This is leading people to take hydrogen more seriously as a future fuel, as long as it is created using renewable electricity. It also leads others to want to make a greater reality of carbon capture and storage.

Forward-looking indices

At this time of immense change, with big technical alterations to how homes are heated, transport is fuelled and factories run, the indices which seem to be more on the side of the future often win more friends and supporters. Some of the new technologies have already produced good businesses, generating cash and profit. Others are still speculative, awaiting successful investment in products and projects that people will want.

There can also be wobbles, as we have seen in recent weeks with the clean energy global index after a stunning performance last year. Recent bids for wind sites have worried some investors that big oil companies are in danger of paying too much for new concessions, with implications for future returns on new investments.

Nothing on this website should be construed as personal advice based on your circumstances. No news or research item is a personal recommendation to deal.

Why you should know your index

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