Posts tagged ‘FTSE100’

Breaking Records

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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27/02/2015 at 4:00 pm

Carney Talks!

June 2014 is turning into The Month of the Central Banker. Last week it was the rock star, Mr Draghi, on stage; this week it has been our own (imported) Mr Carney. Yesterday the Governor of the Bank of England set pulses racing when he announced that the base rate, pegged at 0.5% since March 2009, could be heading higher “sooner than markets currently expect.” Never mind that the pace of rises would be “gradual and limited” – nor that there was much else of interest in yesterday’s news about Bank control of mortgage lending criteria, multi-currency facilities and broker lending too. Rates are going up! was the cry that markets took.

The pound, while off its highs for the day, strengthened materially, especially against the euro. The FTSE 100 is back down where it ended April. Short dated gilts took a hit. And market expectations for the base rate, as measured by the three-month LIBOR future, have moved higher in large volume (£234bn worth of the December 2014 contract alone at time of writing).

Yet the moves do not reflect anything like a proper panic so we should not blame Mark Carney for putting on a lousy act. And after all, he has the fundmentals behind him. The UK economy has been growing  strongly – why, we are on track this very quarter to produce the same level of output, in real terms, as we did at our peak over six years ago! And unemployment figures out on Wednesday showed the ILO survey measure down another 0.2% to 6.6%, now lower than in Germany. Pretty soon, even the Bank of England’s pie-in-the-sky inflation modelling will begin to suggest a rate hike is warranted.

There is a more interesting debate to be had, and it is this: how might we expect markets to behave once rate rises become a reality?

With equities down, bonds down, the currency stronger and the property market apparently in the Old Lady’s sights the answer may seem obvious. In any case, with those LIBOR markets now expecting the first rise to come as early as September, it is not that academic.

Doom among asset classes is but rarely universal, however. The market is now pricing for 1-1.25% of tightening in the year to September 2015. This is consistent with the 1.25% occurring from June 2006 to July 2007 and the 1% from October 2003 to August 2004. Taking a proper recession as a starting point, the pace of hikes from July 1994 to February 1995 was a little more aggressive (1.5% over that much shorter period), but policy history and inflation expectations were also different back then.

The gilt market knows all this. But it has had a good year, and might just be expecting inflation over the longer term to remain as subdued as it has been in recent months. In an environment where global activity is picking up, and the Bank of England is sufficiently worried about prices to be hiking base rate for the first time since 2007, there is surely a risk that longer-dated interest rates will have to rise alongside shorter ones.

At the same time, equity markets have generally risen as interest rates have gone up, not fallen, reflecting an alignment of future views on economic, price and earnings growth. Dislocations such as an inflation crisis or the ERM debacle and other factors can skew this logic, but the fact is that over the last 20 calendar years, the base rate has risen across seven of them, and the FTSE 100 index then fallen only twice. When rates have fallen, over eight of those years (they were flat the rest of the time), equities have also fallen twice. We should at least read into this behaviour that the direction of short term interest rates is a poor predictor of equity market performance and not, perhaps, be too concerned about today’s falls as a result.

The message is similar for the currency. The fate of the pound will also hang on what everyone else’s interest rates, growth patterns, equity markets and so on are doing: “rates up, pound up” on anything other than a highly temporary basis is not a view ever worth taking. (Over the longer term, purchasing power might be able to tell us something about the likelihood of sterling’s regaining its pre-Great Recession highs, but that is another story.)

An interesting week for observers of the UK, then, but not one which has provided much of predictive use from short term reactions. Taking a step back, we should view Mr Carney’s announcement as perfectly consistent with a strengthening economic recovery in Britain and around the world – if, of course, that is what we continue to get. There are ideas that might well give us about investment decision making, and it is in the context of such ideas which this week’s news from the Bank should be considered.

13/06/2014 at 5:07 pm

New Bod, Old Tricks

The eagerly-anticipated arrival of Mr Mark Carney as new Governor of the Bank of England apparently produced its first real news this week. Presiding over the regular release of the Bank’s quarterly Inflation Report on Wednesday, Governor Carney announced that UK interest rates will not start going up until the ILO measure of unemployment falls to 7%. This measure has not moved much over the last four years, stuck around an average of 8%, so who is to say when this might happen? But not to worry: the condition is subject to three “knockouts”, which are in fact two. If inflation looks like it might be getting troublesome, then rates might go up. And if the financial system looks like it is imploding due to the low level of interest rates – how this might occur is yet to be clarified – then a change will also be considered.

This generated some coverage, though market reaction was understandably confused. The pound rose somewhat, trade weighted sterling bouncing back to about what it averaged in June. On the other hand stocks fell, with the FTSE 100 falling by 93 points on the day. Meanwhile, gilts bobbled around a bit before finally deciding to do nothing at all.

For the benefit of readers however, this blog can state that there is one new development of note: namely, that the supposed commitment to a 2% CPI target over a 2-year forecast horizon has been effectively abandoned. Its replacement is a supposed commitment to a 2.5% CPI target over a 1.5-2 year forecast horizon (“knockout” number one).

Nobody seems to have noticed this usurpation of the Exchequer but it doesn’t matter anyway. The Bank’s inflation forecasts have been garbage for years. They have consistently underestimated CPI over their forecast period in good times and bad while doing everything they can to drive it higher.

From the volume of comment in the business pages one might find this hard to believe. But it is August, they have to have something to write about and it is true: other than this one change nothing is different. The first paragraph of all the Inflation Reports since February 2004, when CPI took the limelight from RPIX, has read along these lines:

In order to maintain price stability, the Government has set the Bank’s Monetary Policy Committee (MPC) a target for the annual inflation rate of the Consumer Prices Index of 2%. Subject to that, the MPC is also required to support the Government’s economic policy, including its objectives for growth and employment.

Mr Carney’s predecessor was explicitly prioritizing this supposedly secondary aim as far back as January 2011. The emphasis is not new. In fact even the soft target for unemployment is a poor show compared with targeting nominal GDP growth, as some had been hoping Carney would do.

In other words the Bank will carry on ignoring inflation and doing everything it can to push up activity and job numbers (beyond what it has already done: not much).

We must be fair to Mark Carney. As well as presiding over monetary policy he also has a firm to run, and has let it be known that he wants more women at the top of the Old Lady, with a view to one of them becoming Governor in the fullness of time. He is likely to be pre-empted in this ambition by the Fed if recent speculation is to be believed, but then they were the first ones to start linking monetary tightening to specific unemployment figures too so this cannot bother him.

In any event, his legacy is unlikely to be overshadowed by that of the newly-ennobled Mervyn King. All those years at the helm and the only prices he managed to contain were those of the sandwiches in the Bank’s canteen.

Whether Mr Carney manages any better on the inflationary front remains to be seen. The early signs are not encouraging.

09/08/2013 at 5:17 pm

Seasonal Variations

We recently looked at the old adage “sell in May“, wondering whether it would prove as valuable a tip for stock market behaviour as it would have done last year – and (almost, but not quite) in 2010 too. Since then of course, while an investor who sold on May Day itself would still be just about on the right side of the trade, the FTSE 100 index – which averaged about 5,460 over May as a whole – has recovered, and at the time of writing is roughly 5% higher than that.

In reality, “sell in May” – like the January effect, and others – is one of those calendar-based phenomena that don’t really exist. Or being kinder: is an effect which did once exist (perhaps) but has since become less reliable as markets have tended towards greater efficiency over time.

A similar-yet-different seasonal effect is the summer lull. As we described it two years ago, this is the period roughly between Wimbledon and the end of the school holidays when “senior market participants are hosted at a series of high profile sporting events before being flown off to their holiday homes and luxury hotels. Their deserted offices are not supposed to witness much in the way of interesting activity during the period.”

London is in the middle of the highest profile event of them all of course, so it is appropriate that the summer lull seems to be making a comeback.

Sticking with the UK index as an example, the FTSE 100 floated a stately 1.2% higher this July, its smallest percentage movement for the month since 2004. Over the last few years the summer months have been positively volatile: 2008 was marked by darkening gloom as the credit crunch became an international recession, 2009 saw a powerful relief rally, 2010 a significant rebound from the world’s first shock over the situation in Greece, and last year a flash crash from which the recovery remains only partial.

Perhaps the Olympics will combine with the usual features of the summer break to give markets a respite this year. Such an outcome would certainly be welcome to many.

There is, however, a lot of summer left to go. While real catastrophe continues to elude us – waiting in the wings, to take the bearish view – developed world growth remains sub-trend at best, reported earnings and other indicators suggest a period of broadly flat economic activity and there is always some European statement / election / decision / downgrade waiting to terrify everybody.

It’s a rum time for finance when boredom looks attractive. But with one alternative prospect being calamity, that’s the way things are.

03/08/2012 at 4:35 pm 3 comments

Taking Stock

Shares have enjoyed a strong start to 2012. The MSCI World Index of developed country stock markets closed yesterday up 6.5% on the year so far. The Emerging Markets index has done even better, closing up 13.9%. And yet looking at the headlines one might think this overdone. Banks in particular seem to be suffering, with Deutsche Bank for example reporting a 76% collapse in profits only yesterday. Last year markets were arguably too pessimistic in the face of mixed economic data and robust corporate earnings growth. Could they be growing too bold at present and overreacting the other way?

Let’s look at the S&P 500 index. Fourth quarter earnings season in the US is well underway, with just over half the members of the index (273 companies) having reported as of yesterday. Earnings per share for those companies rose 3.5% on the quarter, falling short both of analysts’ estimates (+4.8%) and the 5.4% rise in the index itself. On the face of it this could be taken as a sign of over-optimism.

Digging a bit deeper, however, we find that if we exclude results from the financial sector – which has posted a fall in EPS of over 18% so far – non-financial companies have reported an increase in earnings of 8.2% (against a forecast of +6.5%).

What is important about this is that it is the big banks which were most exposed to last year’s market turmoil. If Deutsche’s investment banking division, for example, had broken even over the quarter instead of posting a €422m loss, profits across the bank as a whole would have beaten analysts’ estimates. We have seen similar stories in US bank results, where poor performance from the market-exposed parts of the business masked continued modest improvements in key bread-and-butter measures such as the size of provisions for loan losses.

Even if we choose to ignore this level of detail, however, stock market indices have a long way to go before they begin to look overvalued. For example, the p/e ratio of the FTSE 100 index has averaged about 14 over the last ten years. Even assuming earnings growth of zero, to match this valuation from the current p/e level of 10.4 would require growth in the index of some 35% – a rise in price to over 7,800.

Of course, it is still possible that some kind of catastrophic collapse will overtake us, and market valuations reflect that fact. But it is at least equally possible that calamity is avoided, that the world’s tortuous recovery continues its uneven path and that over time even the wounds of the banking sector will heal.

The rally in equities so far this year has been swift, and rather surprising. Based on what we know about the valuation of stock market earnings, however, it is too early to say that price levels have got ahead of the fundamentals.

03/02/2012 at 11:57 am

The Year In View

As this will be the last comment to be posted for 2010, it seems the appropriate place for some reflections on the year (almost) gone by.

Since this blog began in July, one consistent view has been that while the world economy would continue to recover, it would do so patchily. Equity markets agreed. At present, the S&P 500 has risen by 11.5% year to date; the Nikkei 225 is down 3.1%. In Europe, the stronger countries turned in some of the best equity market performance in the world, with Germany’s DAX up 18.4% and Sweden’s OMX higher by 21.6%. At the other end of the spectrum, Ireland’s ISEQ fell by 4% and the Athens Stock Exchange General Index stands a staggering 33.7% below where it started the year. Our own FTSE 100 index is in the middle, having risen 9.1%.

Despite the recent sell-off, bond markets – which reached crazy levels earlier in the year – have generally turned in a strong performance over 2010 as a whole. Ten year US, German and UK yields have fallen by 40-50 basis points (0.4-0.5%) year to date, implying price gains of around 3-4%. Unsurprisingly, the exceptions were the more distressed European government bond markets, with ten year Irish bond yields 350bp higher and the yield on ten year Greek paper up by almost 600bp.

Commodities have enjoyed a strong year overall, with the S&P GSCI total return index up some 6%. Behind the headline number, the near Brent Crude future has risen 18% year to date, a figure matched by the Bloomberg Base Metal index. Precious metals continued their staggering run into precarious territory, with gold 26% higher and silver up an astonishing 73%. One of the few fallers was a significant one for the index, however: the NYMEX natural gas future is down 26% on the year.

Finally, in the world of currencies, the big loser was the euro, down over 9% on a trade weighted basis year to date. The major gainers were the safe havens of the yen (up 13.4%) and the Swiss franc (up 12.8%), and the Australian dollar got an 8% boost from the commodity boom. Both sterling and the US dollar are broadly flat.

There are a number of observations that could be made on all of this, and even some hints to be drawn about the future. For now, however, we will limit ourselves to noting the disparity of returns between and within asset classes, underlining the portfolio contribution to be made from decision making at this level. And as to the future, may we wish you a merry Christmas, and a happy and prosperous new year.

20/12/2010 at 2:52 pm

Summer Lull …?

As a brief but heavy rain shower over London heralded the true arrival of summer yesterday, our thoughts turned to the fabled Summer Lull.

This period in financial markets is supposed to begin roughly when Wimbledon starts, and finish approximately as the kids go back to school in September. The theory goes that at this time of year, senior market participants are hosted at a series of high profile sporting events before being flown off to their holiday homes and luxury hotels. Their deserted offices are not supposed to witness much in the way of interesting activity during the period. It is a halcyon season for all concerned.

That, at least, is the theory. Over the recent past the summer has proved anything but quiet.

Last year of course the thundering juggernaut of the relief rally saw the FTSE100 gain 15% across July and August. The same months in 2008 were more convincingly dull (July: down 3.8%, August: up 4.2%), but one month later Lehmans went pop and Footsie shed 13%. In June ’07 it was Bear Stearns – remember them? – and although the market reaction was muted at the time that was the signal that the subprime crisis, which had been gathering itself quietly in a specialist corner of the credit markets for a few months, really was going to shake the world.

Why the trip down memory lane? Well, the equity market recovery from the correction we saw over the spring has seen the FTSE100 rise nearly 8% month to date – the steepest monthly gain, funnily enough, since last July.

Will August see a gentle falling back, giving us overall a traditional summer non-event? Or will it be 2009 all over again?

In the latter case, as we are optimistic about the prospects for the world but cautiously so, we would humbly diagnose a case of heatstroke and position for a cooler reappraisal of market valuations once those City offices have filled up again.

23/07/2010 at 11:38 am 2 comments


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