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The FTSE 100 is finally back at pre-pandemic levels! Here’s why I’m cautious

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Dice engraved with the words buy and sell, possibly in FTSE 100
Image source: Getty Images.

Yesterday, the FTSE 100 closed at 7,384 points. This was a gain of 0.6% on the day. If I rewind back to last year just before the stock market crash, it’s pretty much back to these levels. On 21 February 2020, the market closed at 7,403. From here, it was one way traffic, with the market crashing below 6,000 points in early March. But with a disconnect between the UK economy and the FTSE 100, here’s why I’m not overly celebrating.

The cost of the pandemic

One large change between now versus early 2020 is the huge amount of stimulus put into the economy by both the Bank of England and the Government. It’s hard to find an accurate figure online, but the total spend by the Government is over £100bn. This has gone on initiatives such as the furlough scheme, business grants and other subsidies to help companies weather the Covid storm.

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I’m not disagreeing that pumping-in money was needed over the past 18 months, but it could have a damaging impact on businesses going forward. A lot of the listed stocks on the FTSE 100 have taken advantage of the provisions. Without it, some would have really struggled financially. But this stimulus will end at some point. Then I think we will really see which companies are fundamentally sound and which ones have simply been kept alive by the above help.

So if I’m being asked whether the FTSE 100 and the companies within it are in a better place now, I’m not so sure.

Inflation then versus now

Another point that’s worth thinking about is inflation. When the FTSE 100 was trading back around 7,400 points last February, inflation was around 1.7%. With a target of 2%, this wasn’t a problem. Now, even though the FTSE 100 is trading at similar levels, inflation has almost doubled.

I’m not sure that the index is accurately reflecting the impact that higher inflation will have on the companies within it. The main impact is that businesses will face higher borrowing costs when taking on more debt in the future. This is because the Bank of England will need to raise interest rates to try and quash inflation. 

Higher inflation and cost pressures also sees profit margins squeezed, unless the businesses can raise prices to consumers.

Investing in the FTSE 100 now

The above points do make me a little cautious when looking at the FTSE 100. The UK economy has recovered from the depths of the recession in 2020. Yet I’m not convinced that the market is out of the woods yet.

As an investor, this doesn’t mean I’m going to sell everything. What it means is that I’m going to be selective in the stocks I invest in over the coming months. For example, I’d consider buying good dividend shares, ESG stars and defensive stocks.

Nobody knows where the FTSE 100 will be trading in the next year. But what I am confident on is that in the long run, the trend should be higher.

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Jon Smith and The Motley Fool UK have no position in any share mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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