Interactive Investor

Can the FTSE 100 reach 8,000? The bull and bear points

19th May 2017 17:11

Kyle Caldwell from interactive investor

Earlier this week the FTSE 100 index reached a record high, surpassing the 7,500 points mark for the first time.

The milestone, however, was not greeted with the same sort of investor optimism as the index enjoyed back at its 1999 peak, shortly before the technology bubble spectacularly popped.

Although it is impossible to predict whether the FTSE 100's rich vein of form will continue, below we weigh up the bull and bear arguments, which may offer clues in regards to the general direction the index is heading.

Three reasons to be bullish

Valuations are not excessive

Over the past year the index has gained 22%, but overall the market is not expensive on a couple of key valuation metrics. While the FTSE 100 looks pricey on the price to earnings ratio, with a score in the low 30s, more than double its long-term average of 15, wider market valuations look reasonable.

Richard Stone, chief executive of The Share Centre, for example, points out that "equity valuations for the FTSE All-Share when measured relative to forward earnings estimates are close to historic averages".

Currently, he says, the FTSE All-Share is trading on a one-year forward price/earnings (PE) ratio of 15.2 times.The long-run average PE for the FTSE All Share typically rests somewhere between 14 and 15 times.

Further, he points out that sterling weakness is helping those firms which export and earn profits outside of the UK, while in addition monetary and fiscal policy look set to be supportive for some time yet.

Moreover, according to Research Affiliates, a US company specialising in long-term return predictions across various stock and asset markets, the UK market is neither cheap or expensive on the CAPE measure, which compares a firm's market value with its profits over 10 years. UK equities have an overall CAPE score of 14, the same as the long-term median average. 

Investors are not getting carried away

Fund sales hit record levels in March, according to figures provided by the Investment Association, with equity funds proving the most popular, taking £1.7 billion of retail investors' money. 

But although investors are clearly buying into the rising market, there are signs of caution, as both Targeted Absolute Return and Sterling Strategic Bond feature among the top five selling fund sectors.

Moreover, according to Lloyds Private Bank, which has an investor sentiment index, appetite for gold was on the rise in the month of April. The precious metal is viewed as the ultimate safe haven, as it is generally uncorrelated with the fortunes of equity markets.

On the whole, however, Lloyds Private Bank points out that "sentiment towards UK asset classes remained broadly positive", despite ongoing geopolitical uncertainty.

Little sign of election angst

One of the reasons, perhaps, behind sentiment remaining positive is the fact that next month's general election outcome seems pretty clear-cut. Usually a general election brings together two elements financial markets loathe – uncertainty and political meddling.

But this time around all the opinion polls are pointing to a big victory for the Conservative party, led by current prime minister Theresa May. It is expected that May will strengthen her grip on the House of Commons, upping her majority of 17 to possibly as high as 100. In turn this will give her more compromise cards to play with at the Brexit negotiating table, as there will be less pressure from hardline Brexiteer backbenchers.

Three reasons to be bearish

Brexit uncertainty

Since last June the Brexit vote has had a positive impact on performance of the FTSE 100, with the index rising from 6,000 to today's 7,472 level. The rally has been fuelled by the pound moving in the opposite direction. A weaker pound may leave less in consumers' pockets, but it is a boon for exporters and sectors which have large amounts of overseas revenues or assets.

Given the international nature of the FTSE 100 companies, which generate around three quarters of their revenues overseas, the plummeting pound has led to a rising stockmarket.

But it would be unwise to bank on this trend continuing indefinitely, points out Murray Smith of wealth manager Mattioli Woods, particularly given that the Brexit negotiations haven't started yet. Moreover, the rally is arguably artificial, as opposed to being spurred on by an underlying improvement in the economy.

"Markets operate on a short-term basis, they are reflecting what is happening next week, rather than three years' time. Given that no-one knows how the Brexit negotiations will pan out,  I think it is prudent to adopt a more cautious stance at the present time, particularly given how well markets have performed of late," says Smith.

The real question is whether there is indeed a Brexit Bubble supporting the UK equity market, driven by sterling weakness and apparent UK economic insensitivity, according to Guy Stephens, technical investment director at Rowan Dartington,

He adds: "If there is and this starts to deflate for whatever reason, we will need to position portfolios accordingly as the future performance drivers shift."

Trump trade begins to fade

The expectation of reflation borne out of fiscal policy to boost economic activity has been keeping markets buoyant. Donald Trump has pledged to cut taxes, while also increasing infrastructure and defence spending.

But as Richard Buxton, manager of the Old Mutual UK Alpha fund, pointed out earlier this year, the stockmarket rally hinges heavily on all the pledged tax cuts and spending sprees bearing fruit. There's a growing risk that this may turn out to be a classic case of markets moving too quickly, too soon.

Given the US stockmarket is the most influential of all, a setback would likely spill over to other global exchanges.

Concentration risk  

Another reason to be bearish is rooted in the way the FTSE 100 index is constructed. the fortunes of the UK's blue-chip index rests on the performance of four key sectors: banks, insurers, miners and oil & gas producers.

These sectors represent a combined 45% of the FTSE 100 by market capitalisation, and according to Russ Mould, investment director at AJ Bell, wield the greatest influence on the index.

Mould points that out all four sectors "disappointed shareholders in 2014 and 2015 before roaring back into fashion in 2016". "For the FTSE 100 to perform strongly in 2017, these areas all need to deliver the profit and dividends expected of them," he adds.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.

This article was originally published in our sister magazine Money Observer, which ceased publication in August 2020.

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