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Is The FTSE 100 About To Fall Off A Cliff?

After the FTSE 100 hit a new high of 7090 at the beginning of April, analysts and traders immediately started to warn of an imminent crash.

If history’s anything to go by, these are valid concerns. The last time the FTSE 100 reached such lofty levels, the dot-com bubble burst soon after.

And while we don’t usually consider chart patterns here at The Motley Fool, if you look at the FTSE 100 chart over the past 15 years, every time the index has printed a new high close to the key level of 7,000, it has soon slumped back down to 4,000 or lower. 

So, could the same happen this time?

Based on valuation metrics alone it doesn’t look like it. 

Valuation metrics

The FTSE 100’s long-term average P/E is 15. The index is currently trading at a P/E of 14.8, a slight discount to its historic average.

What’s more, the index’s cyclically adjusted price-to-earnings ratio, commonly known as CAPE (price divided by the average of ten years of earnings, adjusted for inflation) was 14.9 at the beginning of this year. Since 1983 the FTSE 100 has traded at an average CAPE of 20.8. 

Another valuation metric, the average dividend yield, also appears to show that the market is fairly valued. Over the past 20 years, the FTSE 100 has supported an average dividend yield of 3.5%. Currently, the index yields 3.6%. 

For growth investors however, the London market does appear to be overvalued. The market currently trades at a PEG ratio of 4.5. 

Outside factors 

The FTSE 100 is a global index. More than three-quarters of the index’s profits come from outside of the UK. 

Unfortunately, this makes the index extremely sensitive to global economic shocks. While the FTSE 100 doesn’t look like it’s about to crash based on valuation figures, macroeconomic factors could drive the index lower. 

For example, Chinese economic growth is slowing, which could have a knock-on effect on the price of miners and Asia-focused banks. Growth within other emerging markets is also starting to slow.

Then there’s the Greek debacle to consider. Unless lawmakers within Europe can sort Greece out once and for all, the country’s troubles will continue to weigh on the market.

Sector-specific 

The FTSE could find support when interest rates begin to move higher again. 

Banks make up a large portion of the index, around 11% in fact. As I’ve written about before, bank profitability is set to explode as higher interest rates enable them to improve their net interest margins.

Additionally, the oil and gas sector makes up another 12% of the index. Any improvement in the price of oil could send this sector higher, helping to push the wider FTSE 100 higher or slow a decline. 

Hard to predict

There are many different outcomes and it’s difficult to try and predict what the future holds for the FTSE 100.

Even some of the world’s most prominent investors fail to correctly identify market trends. More often than not, trying to time market movements can end up costing you a lot of money.

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Rupert Hargreaves has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.