Warning to FTSE 100 shareholders as index nears six-month high

There has been cause for optimism over the past six weeks, but one industry expert doesn’t think it will last. Here’s why they’re so gloomy.

Optimism over an 11% surge for the FTSE 100 index since 12 October was checked today by a warning that markets have underestimated the economic damage of higher interest rates.

Capital Economics thinks London’s top flight will reverse its recent rally and fall to a new cycle low of around 6,700 by mid-2023, before rebounding to finish next year close to where it is now.

The FTSE 100 index rose another 1% today and is now 2.5% higher across 2022 for its highest level since June at just below 7,600.

• Find out about: Transferring a Stocks & Shares ISA  | Share prices today | Top UK shares

Paul Dales, the consultancy’s chief UK economist, said: “Most of the rally seems to have been driven by improving sentiment.

“But this improvement is unlikely to be sustained as corporate earnings are yet to be hit by the deepening UK and global recessions.

“Indeed, while investors’ earnings expectations have fallen as concerns about GDP growth have spread, we still think that they have further to fall given the deteriorating economic outlook.”

“In addition, firms’ margins are still being severely squeezed by the rise in energy prices.”

Today’s latest surge for the FTSE 100 has been built on renewed hopes that global price pressures are nearing their peak and that major global interest rates won’t have to rise as far as had been feared a couple of months ago.

• 10 great companies that are beating forecasts
• Investment forecast for 2023: hot sectors, income and growth
• Is this the top investment idea for 2023?

This expectation was fuelled by today’s reading for November’s euro area inflation, which eased to a lower-than-expected 10% from October’s record 10.6%.

It also emerged at lunchtime that the US economy grew at an annualised 2.9% in the third quarter of 2022, better than an initial estimate of 2.6%. This was offset by separate figures showing that private companies created the smallest number of jobs since early 2021.

A strengthening for commodity prices meant mining stocks were high up this afternoon’s risers board, with copper futures up 3% on supply constraints and expectations of more policy support for China’s economy.

Anglo American (LSE:AAL) shares are now 30% stronger over the past month and Glencore (LSE:GLEN) 12% higher, playing a big part in the recent outperformance of London’s top flight index. In contrast, the UK-focused FTSE 250 is still 18% lower despite a recent improvement as the pound recovers from the mini-budget shock and rate rise expectations are scaled back.

Capital Economics sees the Bank of England raising rates from 3% currently to 4.5% early next year. It forecasts a level of 3% in 2024 compared to the fall to 4% priced into markets.

If that’s the case, it thinks the 10-year gilt yield should decline from 3.10% now to around 2.75% by the end of 2023 and to around 2.50% by the end of 2024.

Dales added: “While the prospect of lower interest rates will eventually buoy equity prices and the pound, we think the markets are underestimating the damage higher interest rates will inflict on the economy.

“That’s why we think the FTSE 100 will reverse all of the recent rally and fall to a new cycle low in the middle of 2023 and why we think the pound will slip from $1.20 now to around $1.05.”