The FTSE 100 is at a record high. So will I keep buying?

The FTSE 100 hit a record high on Friday, beating the previous peak of May 2018. The index looks cheap, but two problems lurk within it. So why am I still buying?

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Last year was gruesome for investors worldwide, as stocks and bonds fell together for the first time since the global financial crisis (GFC) of 2007-09. This made 2022 investors’ worst year since 2008. But the FTSE 100 dodged this storm.

The FTSE 100 hits a record high

At end-1999, the FTSE 100 closed at 6,930.2 — a record closing high. But the stock market crashed in 2000-03, more than halving the Footsie’s value. The index then more than doubled by mid-2007, before collapsing again during the GFC.

Eventually, the index hit a fresh high of 7,877.45 on 22 May 2018. But it dipped again and took almost five years to exceed this mark. On Friday, it hit a record 7,906.58 points, before closing at 7,901.8.

In other words, the index has gained 14% in over 23 years. That’s a yearly compound annual growth rate of 0.57% — a tiny return for almost a quarter-century of risk-taking.

Yet FTSE 100 companies often pay decent cash dividends. Adding these cash payouts at, say, 3% a year boosts this yearly return to around 3.5%. That’s a lot better. Also, no-one invests all their money at the peak, so most UK shareholders’ returns should be comfortably above this figure. Phew!

Betting on the Footsie

Since the GFC, our family portfolio has been heavily invested in US equities. Given the S&P 500’s huge outperformance over other leading indices since (+181.5% since end-1999), I’m pleased with our asset allocation.

But in late 2021, I repeatedly warned that US stocks — especially tech firms — were very overvalued. So we reduced our US exposure and invested more in the ultra-cheap FTSE 100. This helped us to avoid the worst of 2022’s market convulsions. Yet we still lost money, making a loss in the low single digits.

The FTSE 100 faces two problems

For me, the main reason why the FTSE 100 did so well in 2022 was its composition. In short, the index lacks the mega-cap tech stocks that dominate US stock indices, as tech accounts for a tiny proportion of the Footsie’s value.

However, this supposed strength of the index could — over time — become its greatest weakness. The first problem is that the Footsie is dominated by old-economy sectors, including oil & gas, mining, banks and other financials.

Hence, the FTSE 100 is very much dominated by value shares, rather than growth stocks. And when investors rotate away from growth and back to value, then the index could take a beating. This might happen when a global economic recovery gains pace after interest rates peak.

The second problem is that the index is largely concentrated in just 10 mega-cap stocks. Together, these top 10 account for almost £984bn of the index’s total valuation of £2.14trn. That’s around 46% of the total. Thus almost half of the index’s performance is dependent on just 10 companies, which is a concentration risk.

Despite these concerns, I’m still very positive about the FTSE 100’s prospects. Even though it stands at a record high, it looks pretty cheap to me and offers a decent dividend yield. Therefore, I’ll keep buying it in 2023-24, or until its valuation no longer looks attractive.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

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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