Few investors are hugely optimistic about the FTSE 100 at the present time, but it continues to offer superb long-term total return potential. A key reason for this is its valuation, with it being historically relatively cheap.
In fact, the FTSE 100 is trading at the same level as it first reached all the way back in July 1998. That’s almost 18 years ago and this observation provides a degree of perspective on just how cheap the FTSE 100 really is. Further evidence can be seen in the index’s yield, with it standing at just under 4% and having only been materially higher during the credit crunch when the prospect of dividend payouts was extremely uncertain.
In addition, the FTSE 100 trades on a price-to-earnings (P/E) ratio of around 13, which indicates that there’s substantial upward rerating potential. That’s at least partly because the FTSE 100 has a much lower rating than the S&P 500, which trades on a P/E ratio of 16.6. For the FTSE 100 to trade on the same P/E ratio as the S&P 500 it would need to reach around 7,880 points, which is around 28% higher than its current level.
The US and China
As well as being attractively priced, the FTSE 100 is set to soar due to the improving global macroeconomic outlook. Clearly, in the short run there are challenges regarding the tightening of US monetary policy and the transition China is making towards a consumer-focused economy.
However, the US economy continues to record generally positive economic data and is performing well. And although investors became nervous regarding interest rate rises, the first hike is always the most difficult since it marks the start of a new era of uncertainty. But with the Federal Reserve stating that interest rate rises will be gradual, it seems likely that the US economy will continue to grow at a rapid rate.
Meanwhile, China continues to offer unparalleled long-term growth prospects in the consumer goods arena. It has the potential to be the engine room for global economic growth and with a number of FTSE 100 stocks having increasing exposure to China, the index could directly benefit from rising earnings and improving investor sentiment towards China-focused stocks.
As well as an improving global economy and appealing valuation, the FTSE 100 could also move higher as the performance of the resources sector improves. Certainly, this may be something of a slow burner due to the supply/demand imbalance that’s currently causing the prices of a range of commodities to fall and remain low. However, with prices likely to move into equilibrium as supply comes under pressure from what’s an uneconomic and unprofitable situation for many producers, the industry could become increasingly popular among investors.
This is important to the FTSE 100’s outlook since despite the slump in resources companies’ share prices, they still make up 17.3% of the index. As such, they have a major impact on the FTSE 100’s price level and could prove to be a positive catalyst to push the index even higher.
