FTSE 100 nears record high: time to party or panic?

FTSE 100: time to party?

As the old truism goes, the one thing financial markets hate more than anything else is uncertainty - and none more so than currency markets.

Yet while sterling has slid since June's Brexit vote, Britain's FTSE 100 index has been steadily climbing, gaining 15 per cent since recovering from its initial jitters.

The index is now within touching distance of the record high it set last April, when it recorded its best-ever closing price of 7103.

At close of trading on 10 October the FTSE 100 stood at 7097.

WHAT HAS DRIVEN THE FTSE 100 HIGHER?

The rally has been fuelled by the pound moving in the opposite direction, which intensified last week when sterling briefly slipped to $1.15, its lowest level since 1985. A brief 6 per cent decline, described as a 'flash crash', occurred overnight in Asia before the pound swiftly recovered to $1.22.

The falls have been put down to speculative traders being spooked by prime minister Theresa May's decision to steer Britain towards a 'hard Brexit', unwilling to compromise on key issues such as immigration.

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 stock market.

WHERE NEXT FOR THE FTSE 100 AND STERLING?

At such times, however, it is important not to get carried away and chase gains. Angela Murfitt, a chartered financial planner at Fairstone, says that rather than reflecting an underlying improvement in the economy, the FTSE 100's rally has been artificial.

'Before the trade negotiations kick off there will be plenty more ups and downs for the index, so I think at the present time rather than being gung-ho it is more sensible to do some rebalancing. After all a profit is not profit until you have taken it.'

But when taking into account valuations, the FTSE 100 cannot be deemed expensive, according to Matt Hudson, a fund manager at Schroders. Hudson, who manages Schroder UK Opportunities and Schroder UK Alpha Income funds, makes the point that on the cyclically adjusted price to earnings ratio, UK shares are 'cheap', scoring 15.6 versus a long-term average ratio of 20.4.

But on the more familiar price to earnings ratio, UK shares are considered expensive against long-term averages, with a score of 22 versus 15.

Hudson says there is a wide dispersion between the cheap and expensive stocks within the FTSE 100. 'If you believe that other sectors of the UK market, whether financial, or basic materials, or oil, can start to grow again, then this valuation point looks very attractive,' he says.

'Furthermore, if you think sustained rises in inflation are coming, commodities and financial stocks should also benefit in that environment.

'This is all before you begin to look at the market on a more cyclically adjusted basis, or when you look at equities against other asset classes such as bonds. On the latter measure, shares certainly look cheap.'

Tom Stevenson, director of personal investing for Fidelity International, agrees that on valuation grounds the FTSE 100 can continue its winning streak, having gained an incredible 29 per cent since hitting a low of 5499 in February.

'This is obviously good news for UK investors and no-one would complain about the market finally moving decisively on from its 1999 dot.com bubble peak. But it should be remembered that the main reason shares are rising today is the remarkable slide in the pound to its lowest level since 1985. It's good for UK exporters and overseas earners, but for foreign stock market investors it takes the edge off the latest gains.

'Can the market go further from here? Despite coming close to a new high, the valuation of the UK market is not excessive and investors still look to shares for income, growth and stability. It's difficult to predict the best time to be in and out of the market, especially as the best and worst days very often tend to be bunched together during periods of heightened volatility.'

When it comes to currency markets it is also important to go back to the drawing board and look at valuations. One way to go about doing this is to look at long-term averages to assess whether sterling, currently trading at $1.24 (a 13 per cent decline since Brexit) looks cheap or expensive. On a 10-year view the average is $1.64, so on this basis the pound's current level looks cheap.

But the big question, which is pretty much unanswerable until Article 50 is triggered, is how Britain's economy will fare in both the short and the long term. A weaker economy and a weaker pound go hand in hand, and vice versa. As ever, for those who do not have access to a crystal ball, time will tell.


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