I think it’s symptomatic of the low volatility currently permeating stock markets at the moment that we’ve heard a lot of gumpf over the last few days about the underperformance of the FTSE 100 relative to the DAX and the S&P 500 as both the latter markets consistently put in new all-time highs on a weekly basis, while the FTSE100 lags behind.
It is certainly one of those contradictions that have seen analysts, including myself scratching their heads, and pondering why this divergence is occurring and whether or not it is a bearish omen. It is certainly tempting to look for bearish omens given the current concerns about low volatility and falling bond yields, as some equity valuations start to look ever more stretched.
Throughout 2014 both the DAX and the S&P500 have consistently posted new all-time highs, while the FTSE100 has struggled at every turn to push much beyond 6,880 and challenge its previous all-time highs at 6,950.
I’m personally not too fixated on this topic given that the DAX is a total return index, which includes dividend reinvestment and as such it would be surprising if it weren’t at all-time highs. If the FTSE100 was judged in a similar fashion it too would be at all-time highs.
The main drag on the FTSE100 has been weaker commodity prices, particularly gold and copper, concerns about emerging markets, while financial stocks have also underperformed, due to lower trading volumes, lower margins and increased regulatory concerns. Given these sectors make up a good chunk of the market capitalisation of the benchmark index, maybe it isn’t so surprising that the FTSE100 is finding upside progress a lot harder than its peers.
Looking at the FTSE 250, it has outperformed the FTSE100 consistently over the past 5 years, so we may well get some clues to future direction here. While this index hasn’t revisited its highs of earlier this year, a continued improvement in the UK economy is likely to underpin this particular index. The only concern would be is if we drop below the May lows at 15,270.
The S&P500 in contrast, while not being a total return index has the tail wind of continued monetary stimulus from the Federal Reserve, albeit on a slowing basis, as well as perceptions of an improving US economy to drive it forward, as US investors look to price in a continued goldilocks scenario. Valuations here certainly look stretched but many people including myself have been trying to pick the top in this particular market for quite some time with little success.
To quote a well-worn market maxim it’s important to remember that markets can remain irrational longer than you can remain solvent. 
Given this backdrop it remains likely that the FTSE100 continue to underperform, in the same way it has done for the last six months, as shown by the comparison graph above.
Is the current stock market rally stretched? Absolutely, but it won’t be the FTSE100 that tells me that the current rally has run its course; it will be a decline in the S&P500 and the DAX.
The key support on the S&P sits at 1,900 and the German DAX at 9,865. I’ll be monitoring these levels to establish whether a correction is under way.
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