In the last five years, the FTSE 100 has enjoyed a superb Bull Run, which has pushed its price level 30% higher. This equates to an annualised return of around 5.5% per annum. When dividends are added to the figure it is approaching a 10% return each year. Such a strong return has the potential to turn even a modest initial investment into a large cash pile over the long run.
While the index may now be trading close to its highest-ever level, it continues to offer upside potential. It remains relatively cheap, has the potential to rise due to a weaker pound, and could benefit from a continued weak monetary policy across the globe.
Valuation potential
The FTSE 100 currently has a dividend yield of around 3.9%. This is at the upper end of its historic dividend yield range, and suggests that it continues to offer good value for money. This is perhaps unsurprising, since a significant proportion of its constituents operate in sectors which remain unpopular among investors.
For example, over 21% of the index is made up of resources shares, while 22% is financial services companies, banks and insurance stocks. All of these sectors have seen valuations come under pressure in recent years due to low commodity prices and uncertain outlooks respectively. In future, there could therefore be scope for high capital gains which could have a major impact on the index’s price level.
Weak sterling
With the majority of companies listed on the FTSE 100 being internationally-focused, a weak pound has benefitted them in the last year. This trend could continue over the medium term, since Brexit talks are apparently proving to be highly challenging. This could create further uncertainty for businesses, consumers and investors, thereby leading to reduced confidence in the UK economy.
The prospect of difficulties ahead for the UK economy is likely to cause interest rates in the UK to remain at a low ebb. According to recent reports, the Bank of England has little desire to commence a period of monetary policy tightening. Although inflation is edging higher, it is not yet at a level which is causing the economic outlook to deteriorate significantly. As such, in order to boost consumer spending and business confidence, interest rates look set to remain at historic lows. A further weakening of sterling may then cause the FTSE 100 to rise.
Growth environment
A weak monetary policy does not look set to be limited to the UK. The ECB and Federal Reserve seem to have little appetite to raise interest rates. They seem to be more concerned at the prospect of choking off an economic recovery rather than subduing inflation over the medium term. This could create a strong operating environment for the FTSE 100’s constituents and produce higher profitability and valuations over the medium term. This may enhance the index’s level in future and help its investors to generate seven-figure portfolios.