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3 Reasons Why The FTSE 100 Is At A Crucial Crossroad

Despite hitting an all-time high of just over 7,100 points earlier this year, the FTSE 100 is now back to flat for the year-to-date. Clearly, that’s disappointing for investors who, with the global economy showing signs of strength, were hoping that the 3% fall of 2014 would be reversed and that the UK’s leading index would make serious gains this year. 

However, the Greek debt crisis has caused investor sentiment to weaken and the FTSE 100 now appears to be at a crucial crossroad as a result of that issue, plus two other key factors that are on the horizon.

Grexit

Clearly, the situation in Greece is very fluid and is changing by the day (if not by the hour). And, in the short run, the outcome of the 5 July referendum and the discussions between Greece and its creditors are almost certain to have a major impact on the FTSE 100. That’s because the FTSE 100 does not yet appear to be fully pricing in a ‘no’ vote and subsequent breakdown of talks, which could lead to Greece exiting the Euro.

If there is a Grexit, it is highly likely that the FTSE 100 will fall significantly, simply because it will cause the macroeconomic outlook for the EU to substantially worsen. And, with a Grexit having the potential to spur other countries to leave the single-currency region, it could lead to a period of even greater uncertainty – especially if it concerns a much bigger economies than Greece.

Certainly, a deal between Greece and its creditors would improve investor sentiment in the short run and lead to gains in the index level. And, while the outcome is a known unknown, significant volatility is practically certain in the days and weeks ahead.

US Interest Rates

Were it not for the possible Grexit, the focus of the market would likely be on the potential for a US interest rate rise. This is likely to occur in the second half of 2015, with the US economy delivering strong performance and, while no significant inflationary pressures are prompting a rise, the Federal Reserve seems keen to tighten monetary policy while it has the opportunity to do so.

The reaction of investors could be positive, since a rising interest rate in the US shows that the world’s biggest economy is in a strong enough position to live without such a strong monetary stimulus. Or, it could cause investor sentiment to decline, as a higher interest rate has, historically, not been good for equities.

China

The ‘soft landing’ of the Chinese economy continues and is acting as a brake on the bottom line growth prospects for a number of emerging market-focused stocks. Looking ahead, the slowdown in China’s growth rate is likely to continue, since history tells us that annual growth of 7%+ is unlikely to be sustained in the long run.

This slowdown could have a negative impact on the FTSE 100, or it could prompt the Chinese authorities to initiate a stimulus package to try to maintain the country’s growth rate. Either way, China is a large enough global power and market for FTSE 100-listed companies so as to make a major impact on the index’s performance, with its macroeconomic prospects likely to continue to be a major factor in the outlook for the FTSE 100.

Of course, the FTSE 100 has always faced great uncertainty and, while it can cause fear in most investors, periods of uncertainty can also be a good time to invest for the long term.

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Peter Stephens 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.