Is the FTSE 250 overstretched?

Last week the FTSE 250 broke through a psychological barrier as it reached the 10,000 level. Despite the takeover friendly nature of the mid-cap market and the strength of the resources sector in particular, commentators suggest that valuations are become overstretched.

By Annunziata Rees-Mogg

published 9 May 2006

in Features

Last week, a psychological barrier was jumped when the FTSE 250 broke through the 10,000 level, says Ellen Helleher in the Financial Times. Few would have predicted it three years ago, but the FTSE 250 is now in bull-market mode. Indeed, the market is up 160% since March 2003, says Robert Orr, also in the FT.

And the "takeover-friendly" mid-cap market has risen more than 30% in the last six months about double the returns from the FTSE 100. The 250 is now trading 40% above the levels of the dotcom boom, while the main market is yet to get back to its 2000 level. That could be unsustainable, says Orr. "Evidence is emerging that valuations are becoming overstretched."

However, there are good reasons why the mid-cap index has been soaring. Like the FTSE 100, it has benefited from the strength of the resources sector (eight out of the top ten performers on the FTSE 250 are involved in mining or oil exploration, points out Orr) and "both have ridden a wave of mergers and acquisitions". But that could be coming to an end as cash-rich overseas buyers and private-equity groups "are just as likely to bid for the FTSE 100 blue-chip stocks" as they are for the "bite-sized" companies on the FTSE 250.

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It is now hard to believe, says Graham Searjeant in The Times, that two decades ago both of the indices started at the same base of 1,000. "Until the end of the bear market three years ago, the 100 and 250 indices tootled along near enough to each other to recall a motorway and the A road it replaced." The difference between the two indices is to do with the stocks listed. While the FTSE 100 is dominated by banks, pharmaceutical companies and oil and mining groups, the FTSE 250 "offers more variety", says Searjeant. Indeed, the mid-cap index is "considered by many to be the true barometer of the health of UK plc", says the Daily Star.

And while the FTSE 250's outperformance of its larger rival may be part of a trend that goes back to 1999, "these things don't last forever", says Nils Pratley in The Guardian. In fact, the factors that have driven the mid-caps forward are "a lot less positive than they have been", Joe Brent, head of small- and mid-cap research at Citigroup, told Orr. "Investors are advised to be cautious."

Annunziata was a deputy editor at MoneyWeek, covering financial markets, politics, economics and comment pieces. She then went on to the Daily Telegraph as a lead writer where she wrote a column on young women’s financial issues. She was briefly a member of the European Parliament for the East Midlands region in the UK as part of the Conservative Party. Annunziata continues to write as a freelance journalist.