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The FTSE 100’s bargain valuation and 4% yield are too hot to ignore

2017 was a pretty good year for the FTSE 100. At time of writing it stands at 7,603, up from 7,068 in January, after bursting through the 7,500 barrier for the first time and repeatedly breaking new highs. That is a rise of just over 7.5% over the year. Throw in a current yield of 3.95%, and investors have a total return of 11.45%. I’ll take that.

Good, better, best

Yet it wasn’t that good, when compared to rival global indices. Europe rose 20.73% over the year, according to MSCI, with Austria up an incredible 53.54%. The US grew 19.93% while emerging markets smashed it, soaring 25.63% with China leading the charge at 54.47%.

I’ve read a lot of analyst and fund manager 2017 reviews recently, and they all talk about the FTSE 100 in somewhat dour terms. They talk as if it had a bad year, when it clearly didn’t. However, they are more positive about 2018, arguing that recent underperformance will work in its favour, because while many global stock markets now look relatively expensive, particularly the US, the UK is relatively cheap.

Markets up, investors down

Brexit uncertainty has cast a cloud over the UK economy and hit investor confidence, which plunged to a record low in 2017 even as the UK stock market hit a record high, according to research from Hargreaves Lansdown.

The UK economy and the stock market are two very different beasts, with the former stumbling and the latter climbing, but there is contagion in sentiment from one to the other. Domestic investors are fleeing UK equities in droves, withdrawing over a massive £2bn from funds this year. This is the world’s most unloved stock market.

Rational non-exuberance

However, this contagion could work in your favour next year, Hargreaves Lansdown’s senior analyst Laith Khalaf reckons. “Every cloud has a silver lining, and low levels of investor confidence mean the progress made by the UK stock market has not been built on irrational exuberance, and there’s plenty of scope for sentiment to improve from here.”

Investment platform AJ Bell reckons the FTSE 100 could launch a concerted attack on the 8,000 mark for the first time in 2018, despite Brexit, a slowing economy and political risk. Investment director Russ Mould says none of these fears are new and the UK market has three things going for it right now: performance, valuation and dividend yield.

Outlook positive

The FTSE 100 has underperformed global stock markets in sterling terms for two years now, tempting contrarian bulls, Mould says. The latest Bank of America Merrill Lynch fund manager survey shows 37% are underweight UK equities, the highest number since the financial crisis. Also, the FTSE 100 is trading on around a modest 14 times consensus earnings estimates for 2018. This is far, far cheaper than the S&P 500, which is now trading at 31:29, a heady valuation only seen in 1929, 1999 and 2007 (let’s hope it doesn’t ruin the fun). The pound is relatively cheap, which may also tempt foreign investors.

Finally, the FTSE 100 is on a forecast dividend yield 4.3% for 2018, thrashing the 0.47% on easy access cash and the 1.2% yield on 10-year Government gilts. Dividend investors have hit the jackpot this year. The buying signals are flashing.

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Harvey Jones holds the iShares FTSE 100 index tracker. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.