The drivers behind the FTSE 100’s record highs

Britain’s blue-chip index may have started the year by reaching a record high but its gains have been fuelled by a boom in commodity prices and the fall in sterling. So are they sustainable in 2017?

While many investors will see the record levels as reason to rejoice, when we examine the causes of the surge the picture is less rosy.

The fall in sterling is particularly significant: around 70pc of FTSE 100 firms’ earnings are made overseas and any fall in the pound makes them more valuable in sterling terms.

During 2016 the FTSE 100 rose by more than 19pc. However, in US dollar terms – stripping out the positive impact of sterling’s fall – the index actually fell, by 0.2pc.

The rise of the index in 2016 also hides the enormous divergence within it. Looking at the index sector by sector shows that there were some large risers and some steady fallers.

Oil and gas producers rose by 50pc last year, while the FTSE 350 mining index rose by 100pc, according to data from JP Morgan Asset Management. On the other hand, retailers fell by nearly 14pc, while the telecoms sector was down by 21pc and food producers lost 9pc.

Jason Hollands from Tilney Bestinvest, the fund shop, said: “Currency moves rescued markets for UK investors last year. If you were cautious a year ago, with concerns about the uncertain geopolitical outlook, then this year has similar warnings.” He pointed to a “marathon” of European elections and the potential unpredictability of Donald Trump’s presidency.

Chris Wyllie, chief investment officer at Connor Broadley, the wealth management firm, said he did not have concerns about the valuations of British companies but advised investors to be discerning and to “buy the dips”.

“There are going to be some bloodbath sectors for mediumsized firms, retail being one. More businesses will be going to the wall,” he said.

Mr Wyllie pointed to the example of Next, which this week issued a profit warning after slower Christmas sales, and said: “If Next is feeling it, what are the less good businesses out there going to be doing?”

There are two big question marks hanging over Britain in 2017, said Tom Stevenson from Fidelity, the asset manager. The first is domestic earnings. “Economic growth in the UK is probably going to slow down significantly because inflation is likely to rise and that means real consumer purchasing power is going to diminish,” he said.

The other big risk to British shares is Brexit and the associated uncertainty. Mike Bell of JP Morgan said the fall in sterling had priced in a “hard Brexit” that might not materialise.

“If so, sterling will rally and that could reverse some of the gains that we have seen as a result of its fall,” he said.