Chapter 9. Stock Market Indices

It is quite easy to watch the progress of one or two shares day by day, but you cannot possibly spot all the movements of all the shares on the London Stock Exchange.

It can, though, be useful to keep track of how the market generally is faring, so you can tell whether your shares are doing better than average or you can watch for warning signs that the market is weak. So a series of stock market indices has been devised which can tell you how the whole market or various parts of it have moved overall during the day.

Each index is calculated as a figure and the size of the change in that figure reflects the scale of the movement of the market as a whole.

On any trading day, some shares rise, others fall and some stand still. Stock market indices average out the changes to give a representative overall picture. Changes are calculated moment by moment, each change in any share price being reflected automatically.

These changes can be recorded on a chart, just as movements of an individual share price are.

Some indices cover companies of a specific size, such as the largest, the medium-sized ones or just the tiniest. Others comprise specific sectors – that is, all the companies in a particular line of businesses. For example, there are separate indices covering oil and gas, industrials, telecoms and utilities.

Then there are indices for sub-sectors. For instance, as well as an index covering all financial companies, there is an index comprising banks, one for life insurance and another for general insurers.

Meet the Footsie family

While the FTSE 100 index, covering the biggest companies listed on the London Stock Exchange, is the daddy of them all, there’s a whole range of little ‘footsies’ dancing around to help you to see in which direction the stock market is really running.

FTSE stands for Financial Times Stock Exchange – the operation used to be a joint venture between the Financial Times and the London Stock Exchange, but in 2011 the FT sold its share to the LSE.

A FTSE committee decides which companies go into which index. It meets every three months – early in March, June, September and December, always on a Wednesday.

Which companies go into which index will depend on share prices at the close of trading on the previous evening. Any agreed changes will take effect over the weekend that falls ten days later, so some companies will end the week in one index and start the next week (somewhere round about the 20th day of the month) with a new status.

FTSE 100

The FTSE 100, the one usually referred to affectionately as the Footsie, is intended to cover the 100 companies with the largest stock market capitalisations (usually abbreviated to market cap). The capitalisation of a company is the value that the stock market puts on the entire company and is calculated by multiplying the share price by the number of shares that have been issued.

The committee does have some leeway in deciding membership of the FTSE 100, otherwise the index would have companies bobbing in and out every quarter.

The top 90 companies must be included. Any company ranked lower than 110 must be excluded. The committee decides which of the 20 companies in between are in and which are out.

The main consideration is stability. Companies already in the top flight will normally be retained, even if they slip just outside the top 100 on the day that the axe happens to fall. A company that looks as if it is here to stay will take precedence over one that could be a flash in the pan.

Chart 3: FTSE 100 index

Source: Macrotrends

We can see how events affected the index over a 10-year period from the original publication of this book at the end of 2007. The market peaked at around 6,700 points when the global financial crisis burst, wiping out almost half the value of the index.

The slashing of interest rates and the introduction of quantitative easing by central banks in the US, UK and, to a lesser extent, the EU turned the tide, although worries persisted over the crisis in the eurozone, with Greece, Ireland, Spain, Portugal and Italy struggling to cope with sovereign debt.

Eventually the eurozone crisis eased and global economic growth slowly picked up, helping the index to reach new highs. It is interesting to note that the referendum vote to leave the European Union, which caused the FTSE 100 index to fall by 500 points the following morning, had a short-lived effect. It subsequently looked like a minor blip.

FTSE 250

Immediately below the FTSE 100 is the FTSE 250, which covers the next 250, medium-sized, companies. This is often referred to as the midcap index, because it is the one covering shares with middle-sized capitalisations.

Again, the committee has discretion over which of the borderline cases are included at the bottom end. We can see how the midcaps moved over ten years in the following chart.

Chart 4: FTSE 250 index

Source: MoneyAM

While the two charts follow roughly similar patterns, the FTSE 250 index is more responsive to domestic UK issues than international issues, as it contains fewer global giants. The recovery after the credit crunch was stronger and the impact of the eurozone crisis was less severe, but the Brexit vote had a greater effect.

Comparing the above chart of the FTSE 250 index with that of the FTSE 100 index, it is not easy to spot which index has been the stronger performer. This can be seen better in the following chart, in which the two indices are re-based to the same starting point. This time we have taken a five-year span because there has been a more clear-cut divergence over this period.

Chart 5: FTSE 100 Index v FTSE 250 Index

Source: London Stock Exchange

We can clearly see that the FTSE 250 performed much more strongly over this time frame. We can also see the greater impact of the Brexit vote, as this point in mid-2016 was where the gap narrowed temporarily.

Two points are worth remembering:

1. The FTSE 250 is more volatile than the FTSE 100.

2. The FTSE 250 is likely to turn the corner after reaching a peak or trough earlier than the FTSE 100 – despite a popular misconception that it is the other way round.

The overall picture is that it was possible to make more trading profits in midcap stocks, reflecting the higher degree of risk and the emergence of new potential high fliers that had previously been unnoticed and undervalued.

One other reason for the apparently sluggish performance of the FTSE 100 index is that its component companies were more likely to pay steady dividends, so the investment rewards came in income rather than share price gains.

FTSE 350

The FTSE 100 and 250 are combined in the FTSE 350 index, which therefore comprises the 350 largest companies. This is an often ignored member of the family. After all, it tells you little that you can’t see separately in the 100 and 250 versions.

The FTSE 100, 250 and 350 all contain precisely the number of companies that are in their names but the other indexes that are worth looking at are elastic. They grow or shrink according to the number of companies that happen to be kicking around.

FTSE Small Cap index and FTSE Fledgling index

The FTSE Small Cap index covers the smaller (but not quite the smallest) companies with a stock market listing. The smallest of all go into the FTSE Fledgling index.

FTSE All-Share

Just to show that we have one big happy Footsie family, all the companies included in the various indices are lumped together in the FTSE All-Share index, which gives us an overall view of the main stock market board.

There are also FTSE indices for the different sectors such as banking, construction, mining and leisure. These enable investors to gauge how well a particular company is faring compared with its peers, as its rivals are referred to.

The Footsie family has a cousin, the AIM All-share index, which, as its name implies, comprises the stocks quoted on the Alternative Investment Market.

There is an AIM 100 index comprising the 100 largest AIM stocks, including foreign companies, and an AIM UK 50 index comprising the 50 largest UK stocks on AIM.

Weightings

Every day some shares go up, some go down and some are unchanged. That happens even when the stock market as a whole is moving strongly in one direction or another. In addition, some shares may move heavily on a particular day while others change just one or two pence.

Each index must therefore calculate the average overall movement of the constituent companies. Companies are weighted according to their stock market capitalisations, so share price movements of larger companies have a greater impact than those of smaller companies.

This prevents a sharp change in the share price of a small company having a disproportionate effect on an index, especially the All-Share index.

The following table is taken from the FTSE website www.ftse.com. It shows the weightings of the ten largest stocks at the end of 2017. Note that the companies, and certainly their weightings, can change over time.

Table 8: FTSE weightings for top ten constituents

Before the credit crunch, the top ten was dominated by banks. Now only two remain, although one admittedly occupies top spot. Banks are now rivalled by oil and gas and pharmaceuticals as the most prominent sectors.

The top ten account for nearly 40% of the FTSE 100 index.