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Financial Times: On London: FTSE 100 spivvs itself up as oil and gas values rise: Saturday 3 September 2005


By Christopher Brown-Humes


It sounds perverse. High oil prices are meant to be bad news for shares, either because they increase inflation or because they slow economic growth. So how is it that the FTSE index has climbed nearly 100 points this week, even though oil prices were hitting record highs? One reason is that two of the biggest stocks in the index – BP and Royal Dutch Shell – benefit from higher oil prices and saw their shares rise.


Since July’s merger between Royal Dutch and Shell, oil and gas has become the biggest component of the FTSE 100 index, accounting for just over 20 per cent of its market capitalisation. This marks an important change. With its preponderance of pharmaceutical companies, telecom operators, banks, utilities and oil and gas companies, London has until recently been viewed as a defensive market.


But the merger has served to highlight what the rising value of the UK’s oil and gas and mining groups was making increasingly apparent – the London market is more leveraged to the economic cycle than conventional wisdom suggests. One strategist goes so far as to say that the blue-chip index has an increasingly “spivvy” feel to it.


The fact is that three companies alone – BP, Royal Dutch Shell and BG Group – account for a fifth of the FTSE 100 index’s total capitalisation. Mining stocks in the shape of Rio Tinto, Anglo American, BHP Billiton, Xstrata and Antofagasta account for a further 5 per cent. So the combined weighting of oil and gas and mining today is 25 per cent, against just 16 per cent four years ago.


It’s not that the FTSE 100 has become a punt on the oil price, but retail investors holding FTSE 100 or FTSE All Share trackers need to realise that the performance of their fund will increasingly be affected by global energy and commodity prices.


That’s fine as long as a strengthening global economy and Chinese demand keep prices high. Both oil and gas and commodities have outperformed this year. The FTSE oil and gas index has risen 26 per cent and the miners by a similar amount, making them the two best performing sectors. Without their contribution, the FTSE 100 index would have struggled to rise half as much. But many observers feel the oil price has been inflated by speculators and that it could fall sharply if global demand cools. At that point, FTSE 100 investors could find out how cyclical the index has become.


One of the strongest consensus calls at the start of the year was that the FTSE 100 would outperform the FTSE 250 as large-cap stocks had their day after years of underperforming their mid-cap counterparts. It’s not turning out that way. The FTSE 250 this week hit a record high of 7,798.5.


The mid-caps have had a good run since May. Global growth has surprised on the upside during this period, which has favoured the cyclical companies that have a stronger proportional presence in the mid-cap sector than the blue-chip. Second, a surge in takeover activity has helped the sector. Since May 1994 there have been 25 takeovers among mid-cap stocks, but only two – Abbey National and Allied Domecq – in the FTSE 100.


The FTSE 100 has also been held back by the underperformance of the banking sector, which accounts for about 20 per cent of the index. Banks have suffered because of their exposure to increasing bad debt levels in the UK. On the other hand, the 250 has a large number of retailers and housebuilders, sectors that are out of fashion because of their exposure to consumer spending.


The mid-cap’s outperformance may be short-lived. Fears about global growth have started to resurface as oil prices have climbed, and the UK economy is clearly slowing. This may hurt the blue-chip index, but it is likely to hurt the mid-cap more, as the latter tends to do worse in a falling market and is more exposed to the UK.


Moreover, the FTSE 100 still looks better value based on valuation and yield. The FTSE 100 currently trades on a price/earnings ratio of 14.01, compared with 18.32 for the 250 index. The yield on the former is 3.19 per cent, against 2.49 per cent for the 250.


Finally, bid activity has reachedt he FTSE 100. This week there was news of Deutsche Post’s approach to Exel. But there are rumours of offers for a number of other FTSE 100 stocks, including O2, Scottish Power and BOC.


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