In April this year the FTSE 100 reached an all-time high of 7,122 points but since then has collapsed to its current level of 6,350. Clearly, that is disappointing, but it could have been much worse. That’s because the index fell to below 5,900 points during its correction in August, but has managed to regain at least some of the lost ground in the following weeks.
Looking ahead, most investors would no doubt say that the FTSE 100 will eventually hit 7,000 points again. After all, it needs to only rise by just over 10% to reach that level. But, in order to get there, there are a number of challenges for it to overcome.
Firstly, the current resources sector decline is extremely bad news for the FTSE 100. That’s because the sector accounts for 17% of the total index, which means that if it continues to disappoint in future months, the FTSE 100 will come under increasing pressure. Realistically, further pain from the resources sector seems to be relatively likely, since the supply/demand imbalance which has been a feature of the oil and gas, as well as the mining sector, looks set to continue.
Secondly, US and UK interest rates will eventually rise and this could have a positive or negative effect on the FTSE 100’s price level. On the one hand, investors may see a tightening of monetary policy as a good thing and become increasingly bullish about the prospects for the world economy, since it shows that the US and UK economies are moving from strength to strength. However, investors may also worry that the low inflationary environment which currently exists will turn to deflation, because of the rising interest rates, thereby thrusting the global economy into another recession.
Thirdly, the slowing of Chinese growth rates is a concern for investors and, as was witnessed in August, has the potential to quickly wipe off 1,200 points from the index’s valuation. Although annual growth in GDP of 7% is more than double that of America, expectations for China were possibly even higher and, should its rate of growth fall further, it could hurt the FTSE 100’s valuation.
Fourthly, the Eurozone may not be front page news at the moment, but it remains a slow growth/high debt region. Clearly, there is potential for it to improve as a result of the current round of quantitative easing and, with the ECB stating that there is more firepower available to it, its future performance may improve. However, it still has the potential to cause volatility in the meantime and, as the UK’s largest trading partner, still matters to a number of UK-listed companies.
Fifthly, the UK will have a referendum on EU membership and this has the potential to dissuade many investors from buying shares in UK-listed companies. Although leaving the EU may not harm the UK’s economic performance, the uncertainty of such a major move could be enough to put off inward investment and hurt the performance of the UK economy, its companies and also its main index.
So, while the FTSE 100 is very likely to hit 7,000 points once more, there are a number of challenges that could delay its progress in the months and years ahead. Of course, there are always economic challenges and, with a number of stocks now trading at very appealing valuations, this still seems to be an opportune moment for long term investors to buy into good companies.