In May 2018, few investors were predicting that the FTSE 100 would fall by over 1,000 points in a matter of months. Back then, there was general optimism regarding the prospects for the UK’s large-cap index, as well as for the world economy.
Certainly, there was a degree of uncertainty regarding issues such as a global trade war and US interest rate rises, but the consensus among investors seemed to be that the growth potential of the world economy was strong enough to overcome them.
Now, though, investors appear to be increasingly cautious about the outlook for the global economy. The FTSE 100 is therefore trading over 13% below its all-time high. However, just as the outlook for the index last May was overly optimistic, the downbeat sentiment which seems to be becoming increasingly prevalent may prove to be misplaced in the long run.
Predictions
Perhaps one of the most challenging aspects of being an investor is trying to second-guess how investor sentiment will change over the short run. At times it feels as though it is random while, during other periods, it appears to be somewhat more logical.
The reality of course, is that the risks facing the global economy and the FTSE 100 are impossible to accurately quantify. For example, future decisions on import tariffs largely rest with a small number of individuals in the US and China whom it’s extremely difficult to second-guess. Similarly, Brexit could go one of any number of ways over the next few months, with its impact on share prices being exceptionally difficult to accurately predict.
Value investing
As a result, it may be more appropriate for investors to focus on valuations rather than trying to accurately predict how investors may or may not feel about specific risks in future. In other words, if FTSE 100 shares appear to offer a wide margin of safety, even though they face potential risks, it may be an opportune time to invest. After all, the world economy faces continual risks, many of which may prove to be less harmful than had been feared.
At the present time, the FTSE 100 has a dividend yield of around 4.7%. This suggests it could offer good value for money, with it historically having an average yield substantially below this level. As such, history suggests that in the long run, its price level could move higher in order to bring its dividend yield into line with its long-term average.
In the near term, its price level may move lower and the risks to global economic growth may prove to be significant. But in the long run, it’s likely to trade significantly higher than its current level. And investors who are able to ignore its performance over a period of months could generate high returns in the coming years, perhaps even £1m if they have a long investing career ahead.