Why the FTSE 250 could outperform the FTSE 100 in 2023

Victoria Scholar of Interactive Investor explains why the FTSE 250 could outperform the FTSE 100 in 2023

Victoria Scholar is Head of Investments at Interactive Investor.

Last year was undeniably difficult for investors, as equity markets suffered from a cocktail of macroeconomic headwinds and the war in Ukraine.

The FTSE 100, an index of the 100 largest companies listed in London, however, proved remarkably resilient, rising 0.9% in 2022. In contrast, the FTSE 250, which hosts the 250 largest companies below the top 100, fell nearly 20 percent.

The UK large-cap index is an outward-looking group of stocks, including many international companies, driven by global economic forces, while the mid-cap index is more domestically oriented, which makes it more correlated to the health of the UK economy and developments. Westminster.

In 2022, the FTSE 100 saw a significant impact from the war in Ukraine. Within the index, an increase in defense spending provided a tailwind for shares and earnings of BAE Systems, an arms manufacturing company.

The ongoing conflict between Russia and Ukraine has also driven up commodity prices, helping BP and Shell to record sky-high profits and British Gas’ parent Centrica has seen a sharp rise in profits due to of soaring energy bills.

The commodity boom has also supported mining stocks, such as Glencore and Antofagasta, which have posted exceptional stock returns in 2022.

>> What does 2023 hold for investors? Hope for lower inflation, an end to rate hikes and a shallow recession for the UK

Pent-up demand for goods and services, post-pandemic global supply chain issues and the war in Ukraine have sparked inflation that hit a 41-year high last year.

The Bank of England has tried to compensate for this by raising rates over the past 14 months, playing into the hands of financial stocks like Standard Chartered which can charge higher rates on loans.

Last year, the FTSE 250 struggled against the UK’s economic deterioration as inflation accelerated and growth slowed.

Additionally, political unrest around the disastrous mini-budget and Downing Street revolving door added to the sense of uncertainty, prompting international investors to shy away from UK companies.

In addition, the fallout from the cost of living crisis has led to a slowdown in domestic consumption, creating difficulties for stocks like Dr. Martens and Aston Martin within the index.

Moving away from pandemic trends

Looking at the pandemic, e-commerce businesses have exploded, while brick-and-mortar stores have been forced to close.

However, in 2022 we have seen a watershed shift with the demise of online shopping, weighing on other FTSE 250 stocks like Asos and Moonpig.

International Distribution Services, which is the parent company of Royal Mail, had its own additional problems as industrial action caused widespread disruption and wiped out its profits.

But is the playing field beginning to even out between the two indices? Both the FTSE 100 and FTSE 250 have had a strong start to 2023 thanks to a recovery in market sentiment, with the mid-cap index so far leading in terms of percentage gain.

Political uncertainty has eased as the UK is expected to narrowly avoid a recession, improving on last year’s rather gloomy forecast.

Moreover, the Bank of England seems to be moving towards less aggressive rate hikes. These factors, combined with the revival of the opportunistic investor jumping into battered stocks, could provide a tailwind for the FTSE 250 this year.

Looking ahead, easing oil and gas prices and new windfall taxes could remove last year’s support for the FTSE 100 commodities giants, while the prospect of a potential interest rate cut by the end of the year by the Bank of England could dampen the outlook for British lenders. .

It’s also important to keep an eye on Sterling. The appreciation of the US dollar last year hurt the pound, while this monetary trend seems to be reversing now. A stronger British pound can create problems for the FTSE 100, as its international companies earn much of the profits in dollars, which, when converted back into pounds, would be worth less.

However, Britain’s FTSE 100 homebuilders are off to a strong start in 2023 with Taylor Wimpey and Persimmon up more than 10% year-to-date as we approach peak interest rates.

Another key development to watch is China’s long-awaited economic reopening, which is already providing support for China-focused FTSE 100 stocks like Prudential and Burberry.

Overall, we’re not necessarily off the hook just yet, but we’re likely to see less disparity between the two UK indices.

2023 will be a bumpy year in tough macro conditions, but there are growing opportunities for investors in both indices, with the potential for the FTSE 250 to lead the way.