2021 has been another year defined by the pandemic. However, things have been brighter than 2020, with the FTSE 100 (LSE: UKX) index rising just under 11% year-to-date and year-on-year. As the UK continues to return to normality in fits and starts, the economy should keep growing. In addition to this, as my fellow Fool Rupert Hargreaves points out, 70% of the index’s profits are generated outside of the UK. This makes it a great opportunity to capitalise on both the domestic and global economic recovery.
The index recently saw one of its biggest daily drops. On 25 November, news of the Omicron variant drove the index 3.6% lower by the end of the day. The reason for this is the effects the pandemic has had on the global economy and could have again if the health crisis worsens. Lockdowns, supply shortages, and travel restrictions are just some of the challenges that Covid-19 has inflicted. These factors impinge on almost all businesses in one way or another. Subsequent reports have suggested that the Omicron variant isn’t as dangerous as first expected. However, its presence still highlights the ongoing threat that the virus poses. I think it’s safe to say that ongoing virus threats will hamper the FTSE’s growth throughout 2022 in one way or another. It just depends on how serious these threats are.
Another problem that I see affecting the FTSE 100 is inflation. Recent data highlight that prices have risen 4.2% in the UK and 6.2% in the US over the past year. In order to tackle this, central banks across the globe are deciding whether to increase interest rates. We’ve already seen the US Federal reserve try to combat inflation by tapering its government asset purchases, decreasing the amount of money in the economy. However, this doesn’t seem to be slowing inflation down, and therefore many investors are expecting a rise in interest rates.
To explain why this is bad for the FTSE 100, let’s use some basic economic theory. When interest rates are low, people invest because they can achieve a higher return than if they just let their money grow using interest. It’s also cheaper to raise debts and use these to invest with. However, as rates rise, the opposite occurs. Some people turn away from investing in equities as they can achieve a similar return from interest on bonds and savings accounts. It also decreases the likelihood of investment as people have to pay more on loans.
FTSE 100 positives
Risks aside, I think the FTSE 100 still offers the safest way to capitalise on the economic recovery of 2022. A key reason for this is the fact that it offers such a diversified investment. Access to a broad range of sectors means that if any sectors underperform, they may be offset by others that are better performers. In addition to this, it allows investors access to all dividend-paying stocks in the FTSE 100. This is a great move to generate passive income for a portfolio.
Yet at present, I’m sceptical of how the FTSE 100 may perform in the next few months and throughout 2022. For me, its progress is heavily reliant on interest rates and how the pandemic impacts the world moving forward. I’m not convinced it can repeat 2021’s impressive growth in 2022. I would therefore hold back from adding a FTSE 100 investment to my portfolio today.
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Dylan Hood has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.