A lot of column inches have recently been dedicated to discussion about the likelihood of a stock market correction, with many commentators saying that the FTSE 100 is due a fall.
There are various reasons given for this, including the fact that the FTSE 100 is near to its record high, that the previous two occasions it was at this level saw huge falls (the tech bubble and credit crunch), as well as a lack of corrections since the FTSE 100 began its current bull run back in 2009.
However, a market fall may not turn out to be a self-fulfilling prophecy, no matter how many market participants are calling for it. Here’s why.
The FTSE 100 Is Not Expensive
Trading on a price to earnings (P/E) ratio of 13.9 and offering a yield of around 3.4%, the FTSE 100 is not particularly expensive. Indeed, its historical average P/E is more like 15, which shows that the FTSE 100 could have further to go than its current level of 6771. Were it to trade at its historic average P/E, it would be sitting at just over 7,300. Furthermore, a yield of 3.4% easily beats gilt yields of 2.7%, which is another indicator that shares could have further to go.
Event-Driven Falls
Certainly, the FTSE 100 has failed to go much higher than its current level on the previous two occasions that it has been reached. However, falls in 2000 and 2007 were caused by a bursting of the tech bubble and the credit crunch, respectively.
In other words, share prices didn’t fall just because the index had reached the high 6000s — they fell because (in the case of the tech bubble bursting), valuations of internet-stocks had become so ludicrous that they simply couldn’t go up much further, while a failure of the financial system caused share prices to fall in 2007.
Obviously, an event of some sort could cause share prices to fall right now, but that’s the case whatever level the stock market trades at. The chances aren’t increased simply because share prices are in the high 6000s.
Looking Ahead
A commitment from policymakers to keep interest rates at historically low levels over the medium term is also a major positive for share prices. Indeed, it should help to provide a boost to the FTSE 100 and its constituents, which also appear to be good value on a relative basis. For instance, the S&P 500 trades on a P/E of 19.3. Were the FTSE 100 to trade on the same P/E, it would currently be trading at 9401.
Therefore, while it is only natural for investors to think a correction is coming due to it happening twice before at current levels, the FTSE 100 could still be a bull’s market for a good while yet.
