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Is the FTSE heading for the magic 7,000?

25 February 2015

Investec’s Max King looks at what has happened to the FTSE 100 over the past 15 years, as some investor start to eye the blue-chip index’s move past the 7,000 barrier.

By Max King ,

Investec Asset Management

It is more than 15 years since the FTSE 100 index peaked at a little below the magic 7,000 level on Millennium eve, 1999.

Professional investors will dismiss the significance of that peak; including reinvested dividends, the FTSE 100 reached a new high at the start of 2006 and has returned a compound 3.4 per cent since the 1999 peak. In capital-only terms, the S&P 500 reached a new peak in mid 2007 and the world index in sterling in mid 2011. While the FTSE 100 has struggled, the FTSE 250 index has multiplied 2.5 fold.

Still, the FTSE 100 index for all its imperfections remains the yardstick by which most people measure stock market performance, a role it took over from the FT30 index more than 30 years ago.

Many investors were caught out by the dramatic drop in stock markets that followed the collapse in the technology-led boom in early 2000 and abandoned equities. Many others abandoned stock markets when they again crashed during the 2008 financial crisis. They will now be wondering whether a new high means that it is safe to go back in or whether it marks the latest peak of a roller-coaster ride.

Performance of index since 30 Dec 1999

 

Source: FE Analytics

Some comfort can be gained from valuations; both world markets and the FTSE 100 traded at over 30 times historic earnings at the 1999 peak but are barely half that now. However, the price/earnings ratio for both the world market and the FTSE 100 were lower than its current level in late 2007.


With the benefit of hindsight, it is clear that corporate profits in late 2007 were about to collapse (though they subsequently recovered quickly) and that investors were hugely complacent about financial risk. Is it different now?

Analysts are collectively predicting high single-digit earnings growth for this year and next, but they were also confident well into 2008. More encouragingly, bond yields are extremely low by historic standards, as are inflationary pressures, making a significant increase in interest rates unlikely. All economic rationale and evidence points to a continuation of steady growth. Management is more focused than ever on maintaining profits, paying dividends and creating value for investors.

Investors, having been hit hard twice in a decade, are cautious and sceptical, scouring the world for bad news which threatens markets. Investors have recovered from despair but the euphoria that marked 1999 and 2007 is notably absent.

The comparison with late 1999 is undermined by the reality that the FTSE 100 index is very different now to what it was then. Fewer than half the constituents then and only a quarter of the original 1984 constituents are still in the index.

Some companies were taken over (such as Cadbury, EMI, Boots and six privatised utilities), some self-destructed (Marconi, Invensys and Cable & Wireless), some failed to live up to their promise (Colt and Energis), some destroyed value through merger (CGU and Norwich Union are now Aviva) and many of the largest companies (BP, Vodafone and Glaxo) appear to be in long term decline. The number of banks has fallen from 11 to 5 while the number of miners peaked at 12 but is now down to 6; then and now, none of them have a single mine in the UK.

In their place, Carnival has taken the place of P&O, having merged with the latter’s Princess subsidiary, Burberry and Experian have prospered as spin outs from Great Universal Stores while Intertek came out of Inchcape.

Weir, Tullow and Next are among those that have emerged from the mid-cap sector but Admiral, Hargreaves Lansdown and Easyjet are among the many that weren’t yet listed. Arm and Sage survived the collapse of the technology sector while Diageo, Rolls-Royce and BAT are among the FTSE 100 veterans that have multiplied in value.

Not only is the valuation of the FTSE 100 lower now than in 1999 but the quality is probably higher. 1998 had marked the culmination of a stampede into large caps while mid and small caps were languishing.

A wave of recent mergers and a number yet to come, especially in the banking sector, were to prove very value destructive. Few of the FTSE 100 in 1999 had their origins as entrepreneurial start-ups; of those that did, Carlton (now part of ITV) and WPP expanded mostly by acquisition while the business models of Colt and Energis turned out to be blind alleys.

The steady growth in both the UK and the global economy are likely to continue for a few years and there is every reason to expect that to be converted into higher corporate earnings and dividends, pushing capital values higher.

The precedents from the past are also encouraging. In 1981, the FT30 index at last regained the 500 level it first reached in 1968 and revisited in 1972 and 1979. Many commentators believed it was time to sell, even though equities had more than halved in real terms. Between then and the end of the millennium, UK equities multiplied ten-fold in value.

Max King is a portfolio manager and strategist within Investec Asset Management’s multi-asset team. The views expressed above are his own and should not be taken as investment advice.

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Data provided by FE fundinfo. Care has been taken to ensure that the information is correct, but FE fundinfo neither warrants, represents nor guarantees the contents of information, nor does it accept any responsibility for errors, inaccuracies, omissions or any inconsistencies herein. Past performance does not predict future performance, it should not be the main or sole reason for making an investment decision. The value of investments and any income from them can fall as well as rise.