How high can the FTSE 100 really go?

The FTSE 100 has risen by 5% in the last three months and by 23% in the last year. It’s therefore safe to say that we’re in the midst of a bull market. The index has risen to an all-time high and is showing little sign of slowing down. Could this be the start of a sustained period of rises? Or is the index now close to enduring a major pullback?

The Brexit effect

The impact of Brexit on the FTSE 100 can’t be underestimated. Since the EU referendum, the pound has weakened significantly versus other major currencies. It now trades at just £1 for $1.21, with its value versus a basket of world currencies being at its lowest in over a decade. This has benefitted FTSE 100 companies in the main, since a large proportion of them report in sterling but trade outside of the UK. Therefore, their sales and profitability figures have experienced a positive translation adjustment, which has sent their valuations higher.

Looking ahead, this could continue to take place. The pound is showing little sign of a sustained fightback. In fact, it could depreciate further once Article 50 of the Lisbon Treaty is invoked and discussions between the UK and EU start. This could lead to heightened uncertainty and reduced confidence in the UK economy. Therefore, other things being equal, Brexit looks likely to continue to positively catalyse the FTSE 100.

Global risks

However, the positive effect of weaker sterling could be offset by global macroeconomic concerns. A new US president could make significant changes to the world’s largest economy. It seems likely that he will increase spending and reduce taxation, but he could also place tariffs on countries such as China. This would be likely to slow down global growth and could lead to reduced confidence among investors. Therefore, demand for riskier assets such as shares may decline and push the FTSE 100 downwards.

In addition, Brexit is just one part of what remains a tough outlook for the EU. The French election is likely to increase uncertainty surrounding the prospects for the euro zone, while poor performance from the political union will also harm the prospects for global growth. As a result, the FTSE 100’s constituents may experience challenges in their end markets, which could cause profit growth to stall and their valuations to come under pressure.

Higher highs

In terms of how high the FTSE 100 could go, the current level of 7,300 points may be the tip of the iceberg. The index has a yield of around 3.6% versus 2.3% for the S&P 500. If the former were to trade on the same yield as the latter, it would have a value of over 11,400 points. While this level may not be reached any time soon, it shows that even though it’s at a record high, the FTSE 100 has significant growth potential. Therefore, buying a range of its constituents for the long term could be a shrewd move.

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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.