Why the FTSE 100 is heading for a new record high
The leading London share index looks set to surpass its 1999 peak. But does that mean it's a good time to grab a piece of the action?
There's a real sense of anticipation among UK investors and money managers this year, because 2014 looks like the year that the FTSE 100 will finally exceed its record high of 1999. But why is it accelerating and does this mean it's a good time to jump into the stock market?
The market's highs and lows
On 31st December 1999, the blue-chip index of elite UK-listed businesses, the FTSE 100, hit an all-time closing high of 6,930 points, having touched 6,950 earlier in the day. Alas, the UK market has yet to regain those lofty heights, thanks to the brutal crashes of 2000-03 and 2007-09.
The good news for patient shareholders is that the FTSE 100 has almost doubled since the dark days of March 2009, when it flirted with the 3,500 level. Indeed, for the first time in almost exactly a year, the index is inching close to a new closing high.
In the past 12 months, the FTSE 100 has ranged from a low of 6,023 to a high of 6,895. It closed on Friday at 6,815. So adding another 115 points would lift the Footsie to a record high and into new and unexplored territory.
Will 2014 see a new record?
Then again, the blue-chip index is up a mere 88 points so far this calendar year, a rise of just 1.3%. Nevertheless, in common with many other market pundits, I believe that the FTSE 100 is set to scale new heights before 2014 is out.
It's said that 'markets climb a wall of worry', so three big questions for nervous shareholders (and would-be investors) are:
- Why is the Footsie riding high at present?
- Do shares look cheap or expensive right now?
- Is this a good or bad time to buy shares?
Here are guarded answers to these three questions.
1. The high-flying FTSE 100
In almost 15 years since the Footsie peaked, share prices have been battered by a series of catastrophes. These include the dotcom crash of 2000, the 9/11 attacks of September 2001, the global financial crisis of 2007-09, the eurozone debt crisis of 2010, and so on.
However, since 2012, there have been remarkably few big economic or political shocks to jolt global markets. What's more, the overall business environment is looking healthy, with the US, Japan and the UK all experiencing above-trend growth in this era of ultra-low interest rates and central bank support.
What's more, right here in the UK, the economic omens look particularly good. At 1.8%, inflation is below the Bank of England's target of 2% a year, so price rises are under control. Our economy is growing strongly, with UK GDP (gross domestic product, or national output) up 3.1% in the 12 months to the end of March. This is the highest yearly growth rate since the final quarter of 2007.
In addition, house prices are booming, up 8% on average in the past 12 months, according to the Office for National Statistics. This 'wealth effect' is boosting retail sales, which leapt by 6.9% in April compared to a year earlier, which is a 10-year high for the high street.
To sum up, in a benevolent environment free of global shocks, investors gain confidence and take on more risk. So it's hardly surprising that risky assets such as shares are doing so well, as buyers add to their existing shareholdings.
2. Are shares cheap?
Sadly, this is a question with no definitive overall answer. The simplest and safest reply is that while some shares do appear good value, others are clearly overpriced.
For example, the FTSE 100 index trades on a forward price-earnings ratio (PER) of 16.8, according to data analysts Digital Look. Since its formation just over 30 years ago in April 1984, the Footsie's PER has ranged from single digits (during periodic market meltdowns) to the mid-20s (in those crazy, bubble years). Therefore, the main UK index is certainly not cheap by historic standards, but nor is it insanely overpriced.
When assessing value, another important indicator to look at is an index's dividend yield. This percentage shows the payout ratio investors receive from cash dividends paid by index members. Right now, the FTSE 100's forecast dividend yield is around 3.2%, which is considerably less than the 5%+ on offer during times of market crisis.
In short, shares aren't cheap, but neither are they wildly overpriced. The best way to deal with this mixed bag is through stock-picking – sifting through individual shares to unearth value bargains.
3. Is this a good or bad time to buy shares?
My best answer would be that the FTSE 100 isn't particularly expensive at present, but nor is it obviously cheap. In these circumstances, I'd be wary of piling into shares, not least because another shock is always on the horizon.
Furthermore, history suggests that now isn't the best point in time to pile into equities. The old market adage "Sell in May and go away, don't come back until St Leger's Day" (the latter is on 13th September this year) has been around since the 18th century for a reason. This is based on a belief (backed by decent empirical evidence) that the period from May to mid-September often produces poor returns – or even losses – for shareholders.
Note that I'm not actually advocating selling up now and buying back in late September for an end-of-year rally. What this will definitely do is lose you money in dealing and transaction charges. What I am saying is that, due to lower trading volumes and fewer company announcements, the next four months could see shares slipping in the typical summer slowdown. What's more, any unexpected shock could see prices plunging and volatility soaring as frantic investors race for the exits.
In summary, it's my view – as a 27-year veteran of investing in shares – that equities may be somewhat overvalued right now, but they are yet to enter an overheated or bubble phase. Nevertheless, with market corrections always arriving unannounced, I wouldn't pile headlong into the UK market at the moment. Instead, I'd wait for the next downturn before buying the blue-chip shares you fancy at knockdown prices!
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