Recent market commentary has focussed on the FTSE 100 price index surpassing its December 1999 peak, leaving many investors wondering what this might mean for the future performance of the market. The truth is, probably not a lot. Looking at price in isolation might be a tempting shortcut to assessing the stock market’s prospects, but digging a little deeper should prove more helpful to investors.
Source: Datastream 28 February 2015
Whilst the level of the market might be similar to the turn of the century peak, the assets you receive in return for that price are quite different today and, on most measures, significantly better value. In 1999, confidence in the economy was very high, and there were lofty expectations for significant productivity gains driven by the emerging force of the internet. This confidence attracted a significant amount of new investment into the stock market, and share prices increased much faster than the earnings power of companies.By the market’s 1999 peak, an investor in the average FTSE 100 company had to pay £30 for every £1 of earnings. Since then, earnings in the market have grown significantly, but overall confidence is not nearly so high. Therefore today, an investor pays around £16 for £1 of earnings. On this very simple measure, today’s investor gets much better value out of an investment in the FTSE than an investor in 1999. At that time, many companies had a highly uncertain future given the inherent unpredictability of the ‘new economy’, compared to the more stable business models among the UK’s largest companies today.
It is also worth considering dividends, as they form an important role in the return an investor receives from the stock market. The FTSE 100 dividend yield in December 1999 was 2 per cent, compared to the 5.5 per cent available in 10 year UK government bonds at the time. Today, the forecast dividend yield on the FTSE 100 is 3.4 per cent, and a 10 year government bond will pay you only 1.8 per cent.
Dividend yield of indices since Dec 1999
Source: Datastream 28 February 2015
On a long-term historical view, it is unusual for government bond yields to be much lower than the dividends of blue-chip shares. Again, this reflects today’s prevailing nervousness around the economic outlook, compared to the heady optimism of 1999.
In fact, if you add in dividends to the price return of the FTSE 100, it actually surpassed its previous peak by the end of 2005, and has continued to make new highs since then – another reason why looking at a price level in isolation from other information can be misleading.
Total return and price performance of index since Dec 1999
Source: Datastream 28 February 2015