Despite wider economic gloom, the stock market has soared in recent years and the FTSE 100 index this week climbed above 6,800 points – the highest it has been since the heady days of September 2000, before the dotcom bubble spectacularly burst.
As the UK’s flagship index sets its sights on an all-time high – 6,930 was achieved in 1999 – many investors with the bravery and foresight to invest in the stock market amid the darkest days of the financial crisis will now be sitting on gains of over 90%. And with dividends reinvested, the index has returned over 120% since March 2009.
While some experts fear a correction is on the cards – and the index did fall on Thursday following a dramatic sell-off in Japan – other analysts have frantically increased their forecasts to account for more optimistic expectations.
Why does the FTSE 100 keep going up?
Many FTSE 100 companies are global brands with worldwide profits. The index is less representative of the UK economy than it used to be so an improving domestic economic outlook is not essential for shares to keep rising in value.
Government and corporate bond yields are at all time lows, fuelled by unprecedented quantitative easing from the Bank of England, and interest rates on cash deposits typically stuck below the rate of inflation. Pension funds and other institutional investors have increasingly turned to shares as managers see few attractive alternatives offering a real return.
The FTSE 100 yields over 3% in dividends and many of the best performing shares in recent years are still paying out in excess of 4%.
The index is up over 25% this year alone, as concerns over a possible break-up of the Eurozone, a theme of market volatility in 2012, seem to have become less widespread.
Is the FTSE 100 still good value?
A popular way of evaluating whether a company or market is cheap or expensive is known as the ‘price to earnings’ (or P/E) ratio.
To calculate a P/E ratio, analysts divide a share price by an earnings per share figure. For example, a company with a share price of £20 and earnings per share of £1 would have a P/E ratio of 20.
P/E ratios can also be calculated for indices as a whole and a low P/E suggests the market might be cheap by historical standards. A study conducted by asset manager JP Morgan in 2012 shows that the 15 year mean P/E ratio for the FTSE 100 is 16.
In 1999 the P/E ratio for the index, fuelled by speculative investment in technology stocks, rose to around 35 before shares crashed. The P/E ratio for the index then fell below 10 at the height of the financial crisis before rising to a current ratio of around 17.