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How the banking crisis changed the FTSE 100 and us

It's five years since the run on Northern Rock began the banking crisis and changed our view of the world. The FTSE looks a lot different now, too.

 

by Caelainn Barr, Gavin Lumsden on Sep 21, 2012 at 17:07

How the banking crisis changed the FTSE 100 and us

A lot has happened since the banking crisis began five years ago with the run on Northern Rock.

A wake-up call

In September 2007 the sight of Northern Rock customers lining up outside the bank's branches to withdraw their money deeply shocked the country. The knowledge that high street banks were teetering on the edge of insolvency as the US sub-prime lending scandal caused a credit crunch that closed off a crucial source of their funding was hugely worrying.

Worse was to come, of course. Northern Rock was the first domino to fall, with its nationalisation followed by taxpayer bailouts for Bradford & Bingley, Royal Bank of Scotland and HBOS / Lloyds. These left the country up to its eyeballs in debt, facing years of austerity and money printing by the Bank of England.

As the scales fell from their eyes suddenly many people saw the limitations of an unchecked credit culture that had brought the financial system to its knees. Unfortunately, just as the virtues of saving and thrift became apparent, turning over a new leaf became a lot more difficult. Unemployment, high inflation, ultra-low interest rates and a rocky stock market have made the past few years an incredibly difficult time in which to save. Nevertheless, figures show consumer debt is slowly falling. 

A more defensive FTSE 100

There have been changes too in the FTSE 100, the index that measures the performance of shares in the 100 biggest companies listed on the London Stock Exchange.

Looking at the two tables you can see how show how Barclays and RBS, as well as mining giants Anglo American and Rio Tinto, have dropped out of the FTSE's top 10 since 2007, leaving HSBC as the only bank in the index's top flight.

Top 10 on 30 August 2012 Market value (%) Price-to-earnings (P/E) ratio
1 Royal Dutch Shell 9.79 10.20
2 HSBC Holdings 6.89 14.50
3 Vodafone Group 6.24 12.90
4 BP 5.72 0.00
5 GlaxoSmithKline 4.97 14.10
6 British American Tobacco 4.45 18.70
7 BG Group 3.00 11.70
8 Diageo 2.98 21.90
9 Bhp Billiton 2.76 9.70
10 Astrazeneca 2.56 7.70

The demotion of the two banks is no surprise given their shares were battered by the chaos that ensued. However, Anglo American and Rio Tinto slipping down the index is more surprising, as the years since 2007 were dominated by a boom in commodities that fuelled mining company profits.

However, this is explained by a shift at the top of the FTSE 100 towards those big companies that pay good dividends to shareholders. Miners have traditionally been a bit mean on this front, although they have improved. With interest rates so low investors have lapped up shares in companies that distribute a lot of their profits as income to investors.

With the global economy weakening it's no coincidence that all of our current top 10 FTSE companies are 'defensive'. By this we mean that the fortunes of drugs companies such as GlaxoSmithKline and AstraZeneca, drinks manufacturers such as Diageo and telecoms providers such as Vodafone are not so dependent on the economic cycle in the way other more 'cyclical' companies are.

Top 10 on 14 September 2007 Market value (%)
1 Royal Dutch Shell 9.79
2 BP 6.89
3 HSBC Holdings 6.24
4 Vodafone Group 5.72
5 GlaxoSmithKline 4.97
6 Royal Bank Of Scotland 4.45
7 Anglo American 3.00
8 Rio Tinto 2.98
9 Bhp Billiton 2.76
10 Barclays 2.56

Michael Clark, a fund manager at Fidelity, a leading investment group, says most of these companies are likely to stay at the top of the FTSE 100 for some time. ‘Companies less sensitive to the economy will continue to deliver decent returns, whereas more cyclical sectors are likely to struggle as it is clear that the global economy has slowed down.

‘Given their relative outperformance investors may start to question if defensive stocks are overpriced. Although many defensive stocks have re-rated [gone up] relative to the market, compared to their own history I do not think this is the case.’

The right-hand column in the first table supports Clark's argument. This shows the P/E ratio of each stock, which measures the relationship of the share price to the earnings per share the company has generated (or is expected to generate).

Royal Dutch Shell's share price, for example, trades at 10 times the earnings (or profits) it made in its last financial year. The P/E ratio is a classic yardstick by which to tell if a share is expensive or good value. Although P/E averages vary from sector to sector, broadly speaking any P/E below 10 is good value and up to mid-teens is fair value. There are many other with which to measure shares but the P/E is a good guide.

On this basis you can see that of the current top 10 only Diageo and British American Tobacco look expensive with P/Es of nearly 22 and 19. It is true, Diageo, the maker of Johnny Walker whisky and Guinness, has enjoyed phenomenal growth in emerging markets in recent years and its shares have grown 21% this year alone. BAT shares have enjoyed a long-term rally having risen 86% in the past five years.

The case for shares (or equities)

Clark, who is A-rated by Citywire for his performance on the Fidelity Enhanced Income , MoneyBuilder Dividend and the MoneyBuilder Balanced funds, explains why shares paying good dividends are in demand.

‘The zero interest rate policy from the Bank of England has pulled down on all financial assets. It has pulled down on the yields of gilts [government bonds] with longer maturities with quantitative easing or buying of gilts and it has pulled down the yields on corporate bonds but it hasn’t really had an effect on equities.

‘Equities remain in the trading range they have been in for a while and that’s partly to do with the fact that yields are low because inflation is very low and we almost have a deflationary environment. So these two factors have combined to depress yields on financial assets generally, particularly on those which are perceived to be low risk like government and corporate bonds. But equities haven’t responded.’

That big FTSE shares like these are still paying good dividends is profoundly good news for savers and investors after the troubles of the past five years. Reinvesting the dividends into more shares or into more units into funds like the ones Clark runs is an incredibly powerful way of boosting your return. It is estimated that dividends account for about 40% of long-term returns from the stock market. So long live a defensive FTSE 100.

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