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Here’s why the FTSE 100 could soar past its record 7,800 points

Image source: Getty Images.

The last month has been hugely challenging for investors not just in the UK, but across the world. Global stock markets have experienced declines, the magnitude of which have not been seen in almost a decade. In some cases, drops have been the largest ever recorded. This has caused the stock market to become headline news, with a sense of panic among some investors and commentators.

However, the reality is that share price falls are nothing new. They have been taking place since stock markets first opened, and prior to that, asset prices have always experienced severe volatility at times. And while the coming months could be a period of yo-yoing for the FTSE 100, the reality is that a new record high is very likely to be ahead.

Investor psychology

While many would like to see smooth and consistent returns on their investments, that is unfortunately not how the investment world works. Those putting their money into shares tend to have a dominant emotion of either fear or greed. In recent weeks there has been a switch from greed to fear, with share prices falling quickly as a result.

Of course, investors have always been fearful at times, while during other periods they have been greedy. Examples of this can be seen as far back as the 17th century, when tulip mania occurred. As most investors are aware, the price of tulips increased to excessive levels which bore no resemblance to their value from a practical perspective. As such, a crash in their price eventually occurred.

More recently, the dotcom bubble saw the prices of technology companies rise to levels which simply could not be justified. Companies with no revenue were being valued on multiples of potential revenue, which was clearly unsustainable. Once enough investors had come to the same conclusion, their over-confidence quickly turned to worry. In response, a market crash occurred.

Outlook

Of course, a market crash may be ahead for the FTSE 100. Inflationary pressures could strengthen in the coming months, with the full impact of Donald Trump’s new taxation and spending policies yet to be fully felt. In such a scenario, interest rate rises could choke off economic growth and reduce the appeal of shares across the globe. And with Brexit ahead, the UK could experience a difficult period.

However, the more likely scenario is that investors will take time to adjust their expectations regarding the future economic outlook. During that time, share prices may be more volatile than they have been in recent years. But the overall trend is likely to be an upward one for the FTSE 100, since it has always gone on to reach higher highs even after the worst crashes in its history.

As such, long-term investors may wish to use investor psychology to their advantage. As Warren Buffett famously said, “be greedy when others and fearful, and fearful when others are greedy.” Therefore, further volatility could be a buying opportunity, with the index likely to soar past its record high over the long run.

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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. 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.