The FTSE 100 index has fallen significantly in the last week or so. Only last Wednesday, the index was above 7,500 points, yet now it’s hovering around the 7,050 level. If, like me, you have checked your portfolio in recent days, you will have most likely been greeted with a sea of red. So what’s going on? Why is the FTSE falling so sharply?
Rising bond yields
The main issue that investors are panicking about right now is rising bond yields. In the US, the Federal Reserve is lifting interest rates (three rate hikes this year already) and the 10-year government bond yield (Treasury yield) has recently risen above 3.2%, its highest level since 2011. A year ago, the yield was around 2.4%.
This yield is the global benchmark for borrowing costs and is watched by many investors as it generally signals the long-term risk-free rate that investors can earn on their money. If the yield rises, it makes ‘risky’ assets, such as shares, less attractive. In other words, investors may decide that investing in shares is no longer worth the risk if they can pocket a return of 3.25% per year, risk-free.
So this goes a long way towards explaining the recent market sell-off. Investors appear to be moving away from stocks and picking up higher yields in the bond market.
One group of stocks in particular that’s getting hit due to higher bond yields is the so-called ‘bond proxies’. These are blue-chip stocks that pay regular, dependable dividend streams (similar to bond coupons) such as Unilever, Diageo and British American Tobacco. In recent years, with bond yields so low, the bond proxies were very popular with investors who were looking for yield. However, now that bond yields are rising and investors can earn higher interest rates risk-free, investors are dumping them. Given that the FTSE 100 is full of high-yielding dividend stocks, and many have large weightings within the index, it’s no surprise the index is suffering.
Another issue is that when bond yields rise, investors also start to panic about companies with debt. With interest rates rising, these companies face higher interest costs and that means lower profits. This, in turn, translates to lower share prices. The FTSE 100 is home to a number of highly-leveraged companies, which also helps to explain the recent market sell-off.
US market sell-off
Lastly, we have the US stock market, which has also fallen sharply over the last week. Last night, the Dow Jones fell a huge 832 points, or 3.15%. Similarly, the S&P 500 index fell 3.29% and the Nasdaq fell 4.08%. Investors are clearly in panic mode. As the world’s largest stock market, the US sets the tone for every other market in the world. If US stocks are plummeting, it’s highly likely UK stocks will be falling too.
So, that’s why the FTSE 100 is falling right now. Of course, it’s not pleasant when stocks are declining, but it’s important not to panic as corrections are a normal part of market activity. In my next article later today, I’ll be looking at how to deal with the market volatility.
It's easy to make a million by using a simple strategy such as tracking the FTSE 100 and letting your money work for you. Unfortunately, most investors 'over-trade' and, as a result, their returns suffer significantly...
To help you avoid this key mistake, the Motley Fool has put together this free report entitled "The Worst Mistakes Investors Make". These mistakes can cost you thousands over your investing career but the best part is, this report is free to download.
Click here to get your copy today.
Edward Sheldon owns shares in Unilever and Diageo. The Motley Fool UK owns shares of and has recommended Unilever. The Motley Fool UK has recommended Diageo. 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.