FTSE 100 and 250 finish 2017 with records, but are they riding for a fall?
New highs for FTSE 100 and 250: what next?
Your view on this one seems to depend on your disposition - are you an optimist or pessimist, a natural bear or bull? Because frankly, a case can be made for saying UK stock markets are both under and overvalued.
Take, as an example, the effect of the pound. We are told that as most members of the FTSE 100 do the majority of their business outside of the UK, the post Brexit falls in sterling had the effect of boosting earnings, once they are converted into sterling. In short: the falling pound is good for the FTSE 100. Ergo, the index has put in a strong performance since the Brexit vote. But if this argument is right, explain why it is that actually, relative to stock markets abroad, the FTSE 100 did relatively poorly.
For that matter, the FTSE 250, which is meant to be a more accurate bellwether of the UK economy, had a better year than the FTSE 100 - the 250 was up 12.5 per cent, the 100 was up by just over seven per cent.
Now I read that the pound is expected to have a good 2018, on the back of more stable economic conditions and progress with Brexit talks. And yet I also read these same drivers will push up on the FTSE 100.
I am sorry, but you can’t have it both ways. You can’t argue in one breath that the cheap pound is boosting UK stocks, and in the next that a recovering UK plc lifting the pound will be good for the index.
Is the FTSE 100 cheap relative to valuations? Once again, the answer depends. Look at the trailing PE, and the index is horrifically overvalued, look at the CAPE, which compares valuation with earnings over the previous ten years and the index looks quite cheap.
According to ICE data, the FTSE 100’s PE is 33 against an historic average of 15. But the CAPE is around 16, roughly the same as the historic average, but well below the 20-year average of 20.
Much seems to depend on the commodity cycle. If this is set to turn upwards, as many predict, then average earnings of FTSE 100 companies will shoot up, and the trailing PE will no longer seem weak.
The bearish case
There seems to be two core arguments put forward by the bears: markets have been distorted by low interest rates and irrational exuberance.
Actually, when you drill down, I think you find one common factor: QE.
The bear case says that record low interest rates and money printing via QE have so distorted the markets, that when rates start to rise, stocks will crash. As for the irrational exuberance argument, they point to bitcoin.
But I am not persuaded by either argument. Sure, bitcoin is a bubble, but I think a lot of its surge can be put down to ignorance. There is a sense that technology is changing the world, but the markets are not sure how. When you really look at bitcoin you find a distrust of central banks bordering on paranoia. Bitcoin is a libertarian’s dream: a money system over which central banks have no control, that cannot be distorted by QE.
That is why when you drill down you find QE lies behind the rises in the bitcoin as well as arguments that market prices have been artificially distorted.
I am not so pessimistic. I believe that QE stopped the developed world from descending into a Great Depression, that may have lasted for a quarter of a century.
Rates are now going up in the US and UK, and QE set to come to an end in the euro area as the prospects for the developed world’s economy are the strongest in over ten years.
I am more concerned about the rise of political extremism, intolerance and hard-man governments than I am worried about interest rates rising from exceptionally low levels to levels that are merely unusually low.
These views are those of the author alone and do not necessarily reflect reflect the view of The Share Centre, its officers and employees.