A while back I wrote about the confusion between what’s performing best/worst on the UK 100 and what’s actually driving the index higher or lower. Because they are not necessarily one and the same. In fact, the difference can be quite startling. Because it all depends on how big a company is in terms of market capitalisation (value) and percentage weighting. Yes, big percentage share price moves are the most exciting ones for the media to report on, however, these may have little or even no bearing on what is moving the index up or down. Meaning we are not always getting the full picture about which stocks or sectors are in the driving seat.

For example, the UK Index is offside by around 550pts from the turn of the year, however all we hear about is engineer GKN, broadcaster Sky and Irish packaging maker Smurfit Kappa, all up by at least 30% thanks to takeover bids. But these only make up a measly 1.74% of the index so why should we really care? That said, because only 13 of the index’s 100 members are up by more than 5% this year, the three beneficiaries’ outsized gains from M&A interest mean that they are, in fact, helping deliver some of the biggest positive index contributions. Even if it’s a very unimpressive 40pts (0.56%).

At the other end of the spectrum we find software seller Micro Focus (-25%; poor H1 results in Jan), tobacco giant Imperial brands (-22%; bond-proxies out of favour as yields rise), retail space Hammerson (-21%; UK high street retail sector woes) and gold miner Randgold Resources (20%; gold prices off highs, stronger GBP). Once again, however, these names make up less than 2% of the UK Index index (1.91%) and are only actually depriving the index of a pitiful 24pts (0.33%).

So, with the index down by over 500pts for the year, the culprits must be elsewhere and our analysis shows the likes of oil giant Royal Dutch Shell (8.6% weighting), tobacco monster British American Tobacco (4.5%), banking behemoth HSBC (6.5%), fellow oil giant BP (4.3%) and consumer goods titan Unilever (4.8%) – almost 30% of the index; top five by percentage weight  – holding the index back by a whopping 245pts; pretty much half the index’s points decline to date. That’s just five names dominating the index’s 2018 drop.

My point is that the heavyweights have a much bigger influence, and yet their moves often go unmentioned because their shares don’t register the big 5% moves which catch the media’s interest. For example, a 1% move for HSBC (6.5% weight) is adding almost 6pts to the index today, when the index itself is up just 20pts (30% influence). Shell (8.5% weight) is up just 0.6% today and yet contributing a whole 4pts (20% influence). So the two together make up 15% of the index, contributing the most in terms of points today and yet this will get no media coverage, because today we have easyJet up 2% (bullish pattern) and house-builder Berkeley Group down 4% (disappointing outlook), even if pair represent less than 0.6% of the index.

As you’ve probably worked out by now, with the index down by more than 500pts in 2018, and only a handful of names contributing anything meaningfully positive, the damage is being done by declines by the heavyweights. In fact, looking at all 14 UK Index components weighing more than 2% (50% weight total) we note that they have held the index back by a whopping 345pts so far this year. That’s 62% of the index’s negative move from just 15 stocks. And herein lies the issue. The UK Index is dominated by just a handful of stocks with outsized influence.

This is key when trading the UK Index , because knowing and understanding what is the architect of the index moving one way or the other, in the short- or long-term. If oil has a big move, that’s 12.9% of the index impacted directly via the oil majors and 25% when you factor in the boost it gives to the commodity sector as whole. So if you are bullish on oil but bearish on the UK Index you have a decision to make, needing to justify your implied contradiction and convince yourself that there is sufficient bearishness across the other 75% non-commodity exposure of the index, and vice-versa.

Part of the UK Index ’s problem this year has been the resurgence of the Pound Sterling. Weakness following the Brexit referendum was a big help to the army of UK Index components, flattering the value of what they earned abroad and the value of the dividends they pay. The recent GBP rally on hopes of both Brexit progress and heightened expectations of a Bank of England rate hike, however, has served to reverse some of this benefit and hurt the London listed blue-chips. And who did this hurt most? Surprise, surprise, the biggest UK Index members. Especially the aforementioned top 5. Hence the UK Index underperforming most other major equity indices this year even as the USD fell to help key commodities prices like oil and industrial metals.

If you trade the UK Index or any of its big name components – like most of our clients – you need to know who’s in the UK Index driving seat. Remember that the top 5 UK Index components weigh 28% of the index. The largest 10 weigh 44%; the top 15 weigh 55%, the top 20 weigh 63%, and top 30 weigh 74%. The UK Index Points Contribution is something we keep our trading floor updated on throughout the day and include in our trading publications. To feel more in control next week, and help your trading, get access to our research. You’ve nothing to lose, and may surprise yourself with how much you have to gain.

Have a great weekend (I’ll be watching the rugby and screaming at the TV)

Mike van Dulken, Head of Research, 16 Mar 2018