The FTSE 100 beat US and European stocks in the first week of 2021. Is this the year it finally outperforms?

The rollout of coronavirus vaccines have helped drive the FTSE higher.

AP Photo/Jay LaPrete

• The FTSE 100 rose more than 6% last week, far outstripping the US's S&P 500 and Germany's Dax. 
• The UK's main index has been boosted by coronavirus vaccines, the Brexit trade deal, and expectations of Democratic stimulus in the US.
• But the lack of a financial services Brexit deal and worries about the UK economy could hold back British stocks.
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The FTSE 100 roared ahead in the first week of 2021, jumping more than 6% compared to increases of roughly 0.13% on the US's S&P 500 and 1% on Germany's Dax.

A number of factors have driven the FTSE higher: the signing of a post-Brexit trade deal with the EU; the approval and rollout of coronavirus vaccines; and the Democrat victories in the Georgia Senate runoff elections in the US.

Each of these promise to aid an economic recovery in 2021 that will help the industrial, financial, and energy firms that make up much of the UK's blue-chip index, and which suffered so much under the coronavirus pandemic in 2020.

But the FTSE is still well behind its peers when looked at over the last year. Whereas the S&P 500 is around 17% higher than it was a year ago and the Dax is up about 5.5%, the FTSE 100 is down roughly 9.5%.

The question investors - from amateur traders to the biggest institutions - are asking themselves is whether the FTSE can continue its winning streak and finally make them money.

FTSE 100 investors look past short-term gloom

The UK economy is in a bad place. A new, more infectious strain of coronavirus has caused cases to soar, forcing the government to bring in tough restrictions. Goldman Sachs now expects the UK to enter another recession in the first quarter.

Should the situation worsen, investors may take notice. Yet for now, they are looking past short-term worries towards what they hope will be a strong expansion later in the year.

In particular, the UK's rapid approval and rollout of the Pfizer/BioNTech and Oxford/AstraZeneca vaccines has lifted investor confidence since December.

"Our view is that 2021 will be about reflation created by global supply constraints and a successful rollout of COVID-19 vaccines," Saxo Bank's head of equity strategy Peter Garnry told Insider.

A return to normality, growth and inflation via vaccines "is positive for interest rates and commodities which benefits banks and resource companies," Garnry said.

The FTSE 100 is chock-full of such companies. Miners Glencore, Anglo American and Rio Tinto all rose more than 13% last week. HSBC and Standard Chartered rose more than 8%.

Another element of the story is that the FTSE 100's laggard status has made it attractive. Neil Wilson, chief market analyst at trading platform Markets.com, told Insider: "You look at the Dax, it's at an all-time high. Euro Stoxx, all-time high … The only one that's cheap with some value left in it is the FTSE."

Brexit could pose a threat

The eventual end to the long-running Brexit saga has also boosted UK equities, with a trade deal removing the threat of a no-deal outcome that so worried markets.

Yet, the UK has still unmoored itself from its biggest trading partner and the deal does next to nothing for financial services. Despite the short-term relief of a trade deal, some analysts say Brexit is still a threat to the FTSE 100.

"Banking stocks have given up some of their pre-Christmas gains as those worries about the potential long term impact leaving the EU will have on financial services filter through," Susannah Streeter, senior investment and markets analyst at Hargreaves Lansdown, told Insider.

NatWest is down around 3% this week, for example, while Lloyds has fallen roughly 1.5%.

Prime minister Boris Johnson has hailed his Brexit deal, but it does little for financial services firms

Paul Grover/Reuters

Samuel Tombs, chief UK economist at Pantheon Macroeconomics, said in a note: "We doubt that 2021 will be the year that UK stocks finally outperform." Many UK stocks are still less attractive than high-flying growth stocks such as the tech giants of the US, he said.

Tombs also cited worries about financial services, and stressed that the deal "has reduced, but not eliminated trade uncertainties."

Reflation trade suits the FTSE 100

Yet FTSE 100 investors are in a jubilant mood. A key part of this story is Joe Biden's victory in the US presidential election and the Democratic party's wins in Georgia, which will give them control of the Senate.

Expectations of extra stimulus under the Democrats have caused bond yields to rise as investors anticipate more issuance from the government and stronger growth and inflation.

The rise in yields - the US 10-year Treasury yield, which moves inversely to price, has climbed above 1% - has helped banks, which benefit from higher interest rates and hold lots of bonds. It has also boosted so-called value stocks, as investors cool slightly on the growth stocks that looked so attractive when yields were low.

Garnry says: "Our view is that the FTSE 100 will do well this year, but because of external factors mentioned above and not the domestic situation which is still gloomy for the UK."

Wilson says: "There are loads of risks. There could be tax hikes in America, more regulation, [and] you've got the risk the vaccines don't really work in spurring the economic recovery."

"But I just think there's just so much money coming, there's so much stimulus, there's so much support."

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