Will the FTSE 100 continue its fine form? We outline the bull and bear cases.
The FTSE 100 index has today (21 May) broken through 7,800 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 of above 6,900, shortly before the technology bubble spectacularly popped.
Although it is impossible to predict whether the FTSE 100’s run of form will continue, below we weigh up the bull and bear arguments, which may offer clues in regard to the general direction the index is heading.
THREE REASONS TO BE BULLISH
Valuations are not excessive
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 14.1, slightly below their long-term median average of 14.3.
Russ Mould, an investment director at AJ Bell, adds: ‘All eyes now will be on whether the FTSE 100 can break through the 8,000 barrier. Admittedly 8,000 does not leave a lot of capital upside for the rest of the year. But if it gets there and stays there that would be a 4 per cent capital gain for the year with a 4 per cent-plus dividend yield on top – still miles better than cash or bond yields, and nicely ahead of inflation.
‘I suspect a lot of people would have been happy with that, had you offered it to them at the start of the year – and now that the index has had a good run and is attracting a lot more positive comment it is probably time to be a little more circumspect and not get too carried away.’
Investors are not getting carried away
The record high for Britain’s flagship stock market index comes a time when both domestic and international investors have been turning their backs on UK equities. Brexit uncertainty is top of investors’ worry lists, but even before the historic referendum vote in June 2016, UK equities were being given the cold shoulder, with the Investment Association’s (IA) UK all companies sector the worst-selling each year since 2014.
‘There’s a famous song that Millwall football fans sing: “Everyone hates us, we don’t care.” That pretty much sums up the current state of the UK stock market,’ notes Richard Buxton, manager of the Old Mutual UK Alpha fund. He adds that global fund managers’ allocation to UK equities is 2.2 standard deviations below the normal allocation, as evidenced in the latest Bank of America Merrill Lynch fund manager survey.
‘Investors don’t want to know, but from a corporate standpoint there’s been plenty of overseas companies bidding for UK companies (since the start of 2018), so they are seeing value. I am siding with the corporates, rather than with retail investors,’ he continues. Examples of UK-listed companies attracting the attention of overseas suitors in the last couple of months include Hammerson, FirstGroup and Sky.
UK profits hit record high
UK-listed companies saw their profits hit new highs in the first quarter of 2018, according to the latest Profit Watch report from The Share Centre.
Profits hit a record £153.8 billion last year and UK plc sales climbed 20.8 per cent to a three year high of £1.33 trillion. This high is the result of a strong global economic expansion together with positive exchange rate effects, which have boosted UK multinationals.
THREE REASONS TO BE BEARISH
Since June 2016, the Brexit vote has had a positive impact on performance of the FTSE 100 index, with the index rising from 6000 to today’s 7800-plus level. For much of the period since the Brexit vote, 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 weaker pound has led to a rising stock market.
But it would be unwise to bank on this trend continuing indefinitely. In fact, since the start of 2017 the pound has been regaining ground against the dollar. But at $1.34, it remains a fair distance away from its level of $1.47 prior to the referendum.
Trump trade begins to fade and trade wars heat up
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, in the event of major pledged tax cuts and spending sprees failing to bear fruit, investors will probably take fright.
There’s also the separate issue of a potential full-blown trade war kicking off, though this appears to have been at least temporarily put on hold. US officials argued the move was necessary to protect US interests against a glut of cheap Chinese steel, but it raised fears that the tariffs will damage both the US and global economy as a result of rising steel prices and also the threat of a wider trade war.
Given the US stock market is the most influential of all, a setback would likely spill over to other global exchanges.
Another reason to be bearish is rooted in the way the FTSE 100 index is constructed. As Money Observer has previously pointed out, the fortunes of the UK's blue-chip index rest on the performance of four key sectors: banks, insurers, miners and oil & gas producers.
These sectors represent nearly half of the FTSE 100 by market capitalisation, and therefore wield a big influence on the index.
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