FTSE 100: is this the perfect storm?

The definition of a ‘perfect storm’ is where a rare combination of factors come together to drastically aggravate a situation. Looking ahead, it could be argued that the FTSE 100 faces a perfect storm during the rest of the year and that its downside risks are far greater than its potential upside.

The most obvious risk facing the FTSE 100 is Brexit. This may not seem all that likely if most of the polls are to be believed, but there have been numerous occasions in the past where pollsters have made major errors with their predictions (such as in last year’s General Election). And with a number of voters being either undecided or seemingly carefree about the issue, there’s a real prospect of Britain leaving the EU as a result of 23 June’s vote.

The effect of Brexit on the FTSE 100 could be severe in the short run. It’s very likely that the UK’s short-term economic future would be thrown into doubt and as such, the index would probably fall by hundreds of points, or maybe even a thousand or two. That’s not because leaving the EU is necessarily a bad thing in the long run, but because investors tend to panic-sell when the future is murky. With the UK having never been outside the EU in many people’s lifetimes, it’s only natural for it to cause fear and a drop in the FTSE 100’s value.

Across the Atlantic

Another factor that could combine with Brexit to create the perfect storm for the FTSE 100 is the US election. Although this won’t happen until later in the year, it’s already shaping up to be a very interesting election. Whatever your view of Donald Trump, Hillary Clinton or any of the other candidates, the US will have a new President within a matter of months and this in itself will cause uncertainty. The result of this could be more selling, less buying and a dip for not only the S&P 500, but for the FTSE 100 as well.

At the same time as the Presidential race is hotting up, the Federal Reserve is set to increase interest rates. While the previously expected four rate rises in 2016 is now extremely unlikely, the market seems to be anticipating some upward movement to borrowing rates prior to the end of the year. Although the first upward move is usually the one that causes the most fear among investors, subsequent rises in interest rates could dampen demand for shares, cause more borrowers to default and hurt consumer confidence. All of these things would be bad news for the FTSE 100.

So, while the FTSE 100 has largely recovered from its dip earlier in the year and has enjoyed a handful of weeks of relative calm, the perfect storm could be just around the corner. For short-term investors, this could be bad news, but for long-term investors it presents an opportunity to buy high quality assets at discounted prices.

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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.