How The FTSE 100 Could Rocket Past 10,000

fireworksYou can always rely on 83-year-old legendary investor Warren Buffett to put things in perspective:

“Over the long term, the stock market news will be good. In the 20th century, the United States endured two world wars and other traumatic and expensive military conflicts, the depression, a dozen or so recessions and financial panics, oil shocks, a flu epidemic, and the resignation of a disgraced president. Yet the Dow rose from 66 to 11,497”.

The UK’s benchmark index, the FTSE 100 (FTSEINDICES: ^FTSE), hasn’t been around as long as the Dow. The ‘Footsie’ was launched on 3 January 1984 at a base level of 1,000. Yet, despite housing boom and busts, a dot-com bubble and crash, the worst financial crisis in living memory, and 8 down years out of 30, the index stands at 6,845 today. We’re talking about a three-decade compound annual growth rate (CAGR) of 6.5% — not including dividends.

You get the idea: in the long run stock markets move ever upwards, even if there’s always something around to worry investors. When the FTSE 100 was down in the dumps in 2009, flirting with 3,500, the pessimists were saying that just because it had fallen 50% didn’t mean it couldn’t fall 50% again.

In fact, in the last five years, far from halving, the index has almost doubled (+95%) from that 3,500 low. And sooner or later it will double again. Certainly, the Footsie has the potential to rocket past 10,000 by the end of this decade.

Here’s how

The Footsie’s 95% gain since the bear-market bottom of 2009, represents a CAGR of 13.6% — well above the long-term average of 6.5%.

Furthermore, a good bit of the rise has come not from earnings growth, which has been relatively modest — as you might expect, given the economic backdrop — but from a re-rating of the index. The price-to-earnings (P/E) ratio has gone from a doom-laden below 10 in 2009 to today’s more optimistic 14; still a little behind the long-term average of 16.

In the next five years, the earnings-growth/re-rating contribution to the Footsie’s gains is likely to reverse. That’s to say, with economic recovery apparently gaining traction, earnings growth should contribute the lion’s share to any gains, with perhaps a modest re-rating of the P/E from 14 to 16.

While the CAGR of 13.6% seen over the last five years may be optimistic — the Footsie would be at around 14,000 by the end of the decade — it wouldn’t be much of a surprise to see the CAGR a bit ahead of the 30-year 6.5% average in this phase of the economic cycle.

At a CAGR of 6.5% the FTSE 100 would rise from today’s 6,845 to around 9,750. A modestly higher 7% would see the index break through 10,000.

Now, I can’t claim to have “20-20” vision, but it seems to me that with the market’s obsession with round numbers there would be a nice resonance in seeing the Footsie hit 10,000 as the calendar rolls into the new decade at 2020!

Of course, as we know, stock markets don't ascend in a straight line. In fact, the Motley Fool's crack team of analysts believe only a handful of companies will make really big gains over the next 12 months.

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G A Chester does not own any shares mentioned in this article.