Here’s The Real Reason The FTSE 100 Continues To Fall!

Back in July, when the Greek drama was all over the news, buffeting markets this way and that by the hour, I suggested company earnings downgrades by City analysts were a more fundamental cause for investor concern.

The FTSE 100 was at 6,673 points when I was writing — 6% down from its spring high — and I suggested the level of downgrades indicated a correction of more like 10%-15% was in order.

Today, market volatility continues, with uncertainty about growth in China and interest rates — among other things — driving sentiment from day to day. But, leaving aside the daily ups and down, there’s no getting away from the fact that the Footsie has moved markedly lower over the past weeks and months. Once again, I’m looking at the fundamental question of earnings forecasts.

The index is currently around the 6,000 mark — 15% off its high. However, the City number-crunchers have further downgraded their company earnings forecasts since July. So, where does that leave us today?

The table below shows the downgrades in consensus analyst forecasts (for 2016) from three months ago to today for the top 10 FTSE 100 companies, which represent about 40% of the index.

Company Downgrade (%)
Shell 14
British American Tobacco 3
GlaxoSmithKline 4
BP 20
SABMiller 5
Vodafone 7
AstraZeneca 2
Lloyds 5
Diageo 7

As you can see, all the FTSE 100 heavyweights have had their earnings forecasts further downgraded since July. As such, while a 10%-15% correction was suggested by the forecasts three months ago, the further downgrades suggest that perhaps around 20% is now in order, which would put the Footsie at 5,680 points.

Of course, there could be further earnings downgrades to come. However, there are signs that the downward trend in forecasts is bottoming out. Indeed, there have actually been some modest earnings upgrades for a few of the companies in the last week or two.

In this light, I would prefer to focus not on how much further the Footsie might fall, but on how far it’s fallen already. A 15% correction is surely a great buying opportunity for long-term investors — even if the index were to go lower in the short term. (You could always keep some powder dry for such an eventuality.)

Also, of course, the index is made up of individual companies, some of whose shares have fallen a lot further than others. For example, Shell and BP — as well as miners, such as BHP Billiton and Rio Tinto, which are just outside the Footsie top 10 — have been major victims of earnings downgrades. But look at their share prices: BP and Rio are both currently 32% below their 52-week highs, Shell is off 36% and Billiton 42%. The near-term earnings outlook may not be great for these companies, but the upside potential for long-term investors is clear.

The same is true for many other companies in the market today.

Of course, investors are generally more comfortable pressing the buy button when next year’s earnings forecasts are favourable — but that tends to mean share prices are relatively buoyant. Psychologically, it’s harder to buy when markets are in a slump, but that is exactly what investors should be doing.

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