The performance of the FTSE 100 has been hugely disappointing in recent months. It has declined by as much as 11% from the record high it achieved in May. Investors have become increasingly concerned about the prospect for a global economic slowdown. There’s a risk of a full-scale trade war between the US and China, while a fast-growing US economy may lead to an increasingly hawkish Federal Reserve.
Those fears may persist in the short run, and could cause further volatility. In the long run, though, the FTSE 100 appears to have the potential to surge higher. Here are three reasons why.
Valuation
At a price level of around 7,000 points, the FTSE 100 doesn’t appear to be overvalued. It has traded within a couple of hundred points of its current level as long ago as 1999. Given that the world economy has grown significantly in the intervening two decades, it could be argued that the FTSE 100 is cheap.
A dividend yield of over 4% is relatively high for the FTSE 100. It suggests that a number of its constituents are still not highly rated by investors, despite the index having enjoyed a decade-long bull market. This could mean that there remains a margin of safety on offer, which may allow for capital gains to be generated over the coming years.
Brexit
While there are various rumours about the UK and the EU being close to a deal on Brexit, the fact is that there remains a significant chance of a ‘no-deal’ scenario. This could create a significant amount of uncertainty among UK consumers, businesses and investors, which may lead to a weaker pound. Since three-quarters of the FTSE 100’s income is derived from international markets, this may provide a boost to those companies which report in sterling, but mostly operate abroad.
Even if a deal is signed between the UK and the EU, there’s likely to be a period of significant uncertainty, which may cause the pound to weaken. In such a scenario, the prospects for the FTSE 100 could improve.
Global growth
While there are concerns about a global trade war and rising US interest rates, the world economy appears to be in relatively strong shape. Certainly, growth rates in the US, China, and other major economies are in a period of change, and volatility could be the end result. But with favourable monetary and fiscal policies being implemented, the outlook for the developed and developing world could be more positive than many investors are expecting.
Therefore, now could be the right time to consider high-quality FTSE 100 shares that are trading on lower valuations following recent price falls. While they could experience paper losses in the short run, due to continued weak investor sentiment, in the coming years they have the potential to generate high returns.
