The FTSE 100 can be a frustrating index at times. Look at a five-year chart, and you’ll see that the index has gone nowhere in five years. In fact, stretch the chart out further and you’ll see that, incredibly, the index is no higher than it was in 1999. You heard that right – the index has gone nowhere in almost 20 years! So what does this mean for investors? Is it time to give up on the FTSE 100?
Lack of growth
To answer that question, I think it’s worth looking at why the FTSE 100 is no higher than it was nearly 20 years ago. There are a couple of main reasons why.
First, in 1999 the stock market was in the middle of a strong bull market, and valuations were high. Indeed, according to data from Siblis Research, the trailing P/E ratio of the FTSE 100 at the start of 1999 was around 23. Clearly, the situation is very different today. While global stock markets have enjoyed a strong run in recent years, stocks are tumbling at present and Brexit uncertainty is acting as an added drag on the FTSE 100. Right now, the trailing P/E of the index is just 13.
Second, it’s important to consider the structure of the FTSE 100. Look at the largest holdings in the FTSE 100, and you’ll mainly see companies in the oil & gas, financial, and consumer staples industries. These are not exactly ‘high-growth’ industries. As such, many of the largest companies in the FTSE 100 now pay out huge dividends to shareholders on a regular basis, instead of reinvesting their profits. In contrast, the US’s S&P 500 index has a large weighting to technology stocks – many of which have enjoyed significant growth over the last decade – which explains why the S&P 500 has soared higher in recent years, while the FTSE 100 has lagged.
Hold or fold?
Considering these factors, I don’t think it’s time to give up on the FTSE 100 just yet. Here’s why.
From a valuation perspective, the index appears cheap right now. Clearly, when the FTSE 100 was trading on a P/E ratio in the 20s back in the late 1990s, it was overvalued. Investors had got ahead of themselves. Yet right now, the index appears to offer quite a bit of value. For long-term investors who are willing to look past the present uncertainty, the current level of the index could be an attractive entry point. As Warren Buffett says, the best time to buy is when others are fearful.
Secondly, the fact that many FTSE 100 companies have paid out huge dividends to investors over the years means that returns from the index have not been as bad as they appear at first glance. For example, while it appears that the index has gone nowhere for five years, a closer analysis reveals that for the five years to 30 November, the index actually generated total returns of around 27%, when dividends are included.
That said, I do think it’s worth having exposure to other indices within an investment portfolio for diversification purposes, simply because the FTSE 100 isn’t perfect. A little bit of exposure to mid-cap stocks, through a FTSE 250 fund, as well as international stocks, through a global fund, could help to diversify a portfolio and boost long-term returns.
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