Following its recent decline of over 14%, the FTSE 100 now trades at a lower level than it did in 1999. Back then, it was riding high on the back of improving investor sentiment as the internet was set to revolutionise the global economy. By contrast, today investors are deeply concerned about the impact of coronavirus on the world economy.
Here’s why now could be a good time to buy shares based on the index’s past performance. Doing so could lead to impressive total returns in the long run, although in the near term there may be more volatility ahead.
Of course, the past 20 years have been hugely eventful for the FTSE 100. During that time it has experienced two bear markets, a number of corrections and countless periods of uncertainty.
Ultimately though, it has failed to deliver any positive capital growth for someone who bought the index in 1999. The main reason for this is that investor sentiment was overly positive during the technology bubble. The internet ultimately proved to be more of an evolution, rather than revolution, in terms of its impact on world trade. As such, the stock market was trading at a high valuation in 1999 that it has failed to experience to the same extent since then.
In fact, at the present time, the FTSE 100 is trading on a relatively low valuation. It has a dividend yield of 5%, while investor sentiment is exceptionally weak. As such, there may be numerous buying opportunities on offer that enable you to take advantage of wide margins of safety across the index.
Reversion to mean
In the long run, the FTSE 100’s valuation could revert to its average level. In other words, its overvaluation 20 years ago did not last in perpetuity. Similarly, its current undervaluation seems unlikely to persist in the long run.
This could mean that it experiences capital growth over the coming years to reduce its dividend yield to a level that is more in keeping with its long-term average of around 3.5%. The timescale over which this may take place is very uncertain, since the overall impact of coronavirus on the world economy is difficult to accurately predict.
However, long-term investors could experience significant capital growth over the coming years. The FTSE 100’s recoveries have generally taken less time than many investors may have predicted during their most challenging periods. As such, while the index may be continuing to fall at the present time, and could decline further in the short run, a long-term recovery seems to be likely as the index reverts to its average valuation.
Buying high-quality FTSE 100 shares that have solid balance sheets, diverse operations, and sound strategies while they trade at low valuations could be a sound move. It may not produce capital growth in the short run, but with the index trading at such a low price level it appears to offer excellent value for money compared to its historic performance.
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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.