Breaking Records

27/02/2015 at 4:00 pm

There was some cheerful news for the UK equity market this week as the FTSE 100 index closed at a record high of 6949, finally beating the previous high – 6930 – it had reached way back on 30 December 1999. This milestone has generated a lot of comment on topics such as its relevance as an economic indicator and whether it comes as a sign that investors should sell. So what, if anything, does the record-breaking date of Tuesday 24 February 2015 tell us about the value of the market?

It has taken more than fifteen years for the 1999 record to be beaten. That is a good long time in financial markets, and perhaps especially so for markets in growth assets which have historically offered long run real returns of 5% per year. Had December 1999 been a textbook average starting point for investing in the UK stock market, then, and dividends from the FTSE 100 precisely matched the rate of inflation over the period we might have expected to see a price return of 1.05^15, or 108%. That would put the index on a level of 14407 rather than 6949 today.

When assessing markets, of course, we should not look at price alone. December 1999 was very far indeed from an average starting point. The price / earnings ratio for the FTSE 100 peaked that very month at 30.5x, de-rated sharply over the next couple of years and continued to descend more gradually, but very steadily, to lows (for the time) of around 12.2x in the summers of 2006 and 2007. This of course reflected the absolute reversal in sentiment from euphoria to depression associated with the collapse in the TMT / internet stock market phenomenon of the 1990s. During the Great Recession and its aftermath the p/e had a few bouts below 10x and has now bounced back to 16.6x, slightly above its twenty-year average level and somewhat lower than the 19.1x midpoint of its low-high range over that period.

Of course what this means is that the valuation picture is much more supportive of this new record price level than it was back when we last saw it at the end of the boom-boom 90s. This is even more the case when we flip the p/e ratio on its head (1/16.6 giving the conveniently round percentage of 6.0%) and compare this resulting earnings yield to a ten-year gilt yield of 1.8% and cash savings rates mostly below that. Back in December 1999 the earnings yield on the FTSE 100 was 3.3% as against 5.5% on the ten-year gilt and, by coincidence, a Bank of England base rate of 5.5% as well.

So breaking the 1999 record is not an obvious sell signal, and tells us at least as much about market sentiment and overvaluation back then as it does about those things today. On the other hand, given how close the current valuation metric is to its long(ish) run average, we should perhaps be expecting a total return of 5% plus inflation should 2015 turn out to be an equilibrium year for the UK market – but wouldn’t you just know it, we’ve had 5.8% of that already for the year to date. Still, a few months’ stagnation now is a small price to pay should that 5% real rate of return compound us forward for the next fourteen years from 2016 onwards. Again making the frivolous but convenient assumption that dividends match inflation, that would put the FTSE 100 on a price of 13758 come the end of 2029.

Perhaps worrying about price points at specific dates is not as useful a decision-making exercise as some others, then, especially when those dates are so very far apart. With the market at its current level it is obvious that it could move in either direction from today until the end of the year. Where it stood in 1999 is really not relevant. Before abandoning the notion of record stock market levels entirely, however, let’s briefly compare the positions of the other major developed-world blue-chip benchmarks.

In the red-in-tooth-and-claw corner stands the S&P 500, which has been consistently making new record highs since early 2013. (Its latest was 2115 on Tuesday, way ahead of the previous cycle peak of 1565 seen in 2007 and the dotcom era high of 1527.) In the very much bluer corner is the Nikkei 225, which rocketed up through Japan’s 1980s economic miracle to a high of 38915 on 29 December 1989. Today it closed at 18797, and will need to grow another 107% before it can eclipse that level, which could clearly take some time. Also looking rather glum is the Euro Stoxx 50, marked at 3572 at the time of writing down from prior peaks of 4557 in mid-2007 and 5464 in March 2000. (As an aside at this point, some of the British commentary on the new record has pointed to Germany’s DAX as an example of an index which has long eclipsed its 2000 peak. Unfortunately, however, the DAX is a total return index, meaning that dividend payments are rolled up in its value, giving it an unfair advantage against plain old cap-weighted price indices like the Footsie. The MSCI Germany index, by contrast, has beaten its 2007 peak but remains below its all-time high of March 2000.)

Again, the various record levels reached by these markets can tell us a lot about the start as well as the end points. The pitch of excitement – and in other parts of the developed world, awe – over 1980s Japan is well captured by that long-ago market pinnacle that will not likely be scaled again for many years. But it is instructive also to look at those peaks and troughs which are common to all these (huge and important) equity markets: highs across the board at the turn of the century, then again in 2007, and on the other hand the sharp falls in Q3 2011 … At times like these markets move in concert because they are thinking in concert – sometimes justifiably, sometimes not. The divergence between their performance over the last couple of years tells us that this is not happening yet. Again, there is good reason why this should be so when we consider differences in earnings, valuation, economic and sentimental factors between the different indices, but it should probably give us comfort too that the new closing record for the FTSE 100 is not part of some global rapture as it was fifteen years ago.

Apart from anything else, it never does any harm when an event like this comes along to provoke thinking and discussion. So well done to the UK stock market for beating its record, and let us enjoy sifting through the analysis before attention moves on.

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