Britain's blue-chip FTSE 100 is primed to reverse a year of underperformance and outpace European peers in early 2013 if its heavyweight mining sector receives an anticipated boost from Chinese growth.
European Central Bank action to defuse the euro zone debt crisis has helped lure investors back to European equity, but while the FTSE has underperformed major continental bourses so far during this rally, it should recoup lost ground next year.
A reduction in bets on London-listed stocks falling and an increase in cash put to work in the mining sector, which, like other cyclical sectors, generally rises or falls with the economic cycle, both point to a positive start to the new year.
The miners will be key to the FTSE's fortunes. They make up 12 per cent of the index - much more than on rival continental indexes - and sharply underperformed in 2012 on concern about slowing metals demand from China.
The pan-European STOXX Europe 600 Basic Resources Index, which includes UK-listed miners, is flat this year against a 14 per cent rise in the broader STOXX Europe 600, so this lag has disproportionately hit the FTSE.
But funds are flowing back into the sector, suggesting better Chinese economic data is starting to give it a lift.
"A China recovery in particular should very much benefit cyclicals, and it should lead to a potential outperformance in the FTSE in 2013," global equity strategist at Coutts James Butterfill said, adding that miners were the most sensitive sector to global growth concerns.
The UK's underperformance has been stark.
The total return, which includes capital gains and dividends, on the FTSE 100 this year has been 9.4 per cent, compared with 17.7 per cent on France's CAC and 26.1 per cent on Germany's DAX.
Euro zone financials benefited disproportionately from a rally that began in July after ECB President Mario Draghi pledged to defend the euro, later unveiling a plan for the ECB to buy the bonds of indebted euro zone states.
UK banks, less exposed to euro zone debt than counterparts in the currency bloc, have gained less from the ECB pledge.
This, along with less exposure in the UK to sectors that gain from economic optimism, were important factors in the FTSE's underperformance, European head of equity and derivative strategy at BNP Paribas Kobou Agbo-Bloua said.
Financials account for just 16 per cent of the FTSE 100, compared to 19 per cent in the rest of Europe, according to FTSE. So, despite UK banks outperforming those in the euro zone on a year-to-date basis, the relative impact on the FTSE is lower.
"Some of the sectors where we're massively overweight have underperformed very significantly, and we've also been handicapped by not being heavily enough exposed to some of the sectors that have done well," FTSE managing director of Research and Analytics Philip Lawlor said.
"It's been a double whammy."
One such overweight sector is mining, which lost 9.1 per cent this year after shedding nearly 30 per cent in 2011 and is three times more heavily weighted on the FTSE 100 than the STOXX Europe 600.
However, China factory data for November showed industrial activity accelerated for the first time in over a year, while government data on industrial output last month showed it rising at the fastest annual pace in eight months.
"The recent positive data and industrial activity in China is also creating support for a sector that has been underperforming recently," Mr Agbo-Bloua said.
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