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Are you tempted by the 7% fall in the FTSE 100? Here’s what you need to know

The FTSE 100 has fallen by 7% in the last four months. Having reached a record high of 7,877 points in mid-May, the index has fallen to around 7,300 points at the time of writing. During the same time period, other major indices such as the S&P 500 have delivered impressive growth despite the potential risks from a full-scale global trade war.

Looking ahead, the FTSE 100 could experience further volatility over the coming months. Brexit is yet to fully play out, while the performance of the UK economy could still act as a drag on its relative performance.

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UK challenges

While the FTSE 100 is often viewed as an international index, the fact remains that its performance is still significantly impacted by the prospects for the UK economy. The UK makes up around 25% of the index’s earnings, so the current uncertainty surrounding Brexit could act as a drag on its performance to some degree.

At the present time, a ‘no-deal’ Brexit seems to be increasingly likely. This prospect could cause the performance of the UK economy to remain downbeat, with consumers, businesses and investors seemingly cautious about the economic outlook. Since the UK is forecast to post a rise in GDP of just 0.5% this year and in 2019, its prospects compared to other major economies seems to be disappointing.

Of course, uncertainty surrounding Brexit could cause the pound to weaken. This could help to counteract the drag on the FTSE 100’s performance from a slow-growing UK economy, since a large proportion of FTSE 100 companies’ earnings could be positively impacted by weak sterling. The end result, therefore, could be high volatility and a lack of clear direction for the index in the coming months.

Global risks

Although uncertainty surrounding the outlook for the global economy given recently-announced tariffs has moderated somewhat, there remains a real risk to global growth from protectionist policies. If further tariffs are placed on goods by the US and China, then it could hurt the world’s economic growth prospects, as well as cause fear and uncertainty to build.

In such a scenario, it seems unlikely that there will be co-operation among the world’s major economies. Unlike in the financial crisis, relations between the world’s superpowers are not especially strong at the present time. This could compound the risks faced by the world economy, and may lead to declines in the FTSE 100’s price level should an economic downturn ensue.

Outlook

With risks and volatility set to be high over the near term, it may seem like the wrong time to be buying FTSE 100 shares. Other assets may offer lower volatility, and seem to have more stable reward prospects. The reality, though, is that the index has always recovered from periods of decline to post record highs. As such, and while the stock market may endure a difficult period in the near term, its long-term investment appeal remains high.

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Peter Stephens has no position in any of the 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.

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