The FTSE 100 rose above 7,000 on Friday. The big-cap index hasn’t traded at this level since markets started to crash in February last year. Should I be taking any steps to change my exposure to the market, or is this a time to sit tight and do nothing?
7,000: what’s in a number?
We all like nice, round numbers. But as a long-term investor, short-term market moves aren’t all that important to me. I aim to hold stocks for long periods so I can benefit from the growth of the underlying business. I don’t just want to trade on share price rises.
Despite this, valuation’s important. I can’t ignore the way that UK share prices have soared since vaccines became available at the start of November.
The FTSE 100 has risen by 25% since 2 November. Many top stocks have done much better than this. Copper miner Antofagasta is up 87%, Barclays bank is up 77% and Premier Inn-owner Whitbread is up 65%.
Has the value of the Premier Inn business really risen by 65% in less than six months? I don’t think so. What has changed is investor sentiment towards the business.
How cheap is the FTSE 100?
Many big companies are now valued at pre-pandemic levels. This suggests to me that investors are expecting a rapid recovery in economic activity across the world — remember, many FTSE 100 companies make much of their money abroad.
To some extent, this is understandable. I don’t think anyone predicted the tidal wave of government money that would be released to support businesses and individuals through the pandemic.
However, as a buyer of shares, I need to look at the downside risks as well. The FTSE 100 is now trading on an average price/earnings ratio of 20, with a dividend yield of 3.3%. I don’t think this is extremely expensive, but prices in a fairly rosy outlook.
One particular area that concerns me is commodity prices. Miners are enjoying some of the best conditions since the last commodities boom in 2011. BHP Group is now the largest company in the FTSE 100, with Rio Tinto in fourth place.
In total, there are four big miners among the FTSE 100’s 15 largest stocks. If miners’ profits were to fall, it could have a disproportionate effect on the index.
FTSE 100: what I’m buying
I’m not buying hospitality or travel stocks at the moment, as I can’t get comfortable with their valuations. For example, Whitbread and Intercontinental Hotels Group are now both valued at pre-pandemic levels.
Although I think both are good businesses that will go on to do well, I didn’t think they were cheap before the market crashed. I don’t think so today either — IHG trades on 68 times 2021 forecast earnings, falling to 30 times earnings in 2022.
What I’m looking to buy at the moment are good quality, defensive stocks that aren’t getting much love from the market at the moment. Companies such as GlaxoSmithKline, Reckitt Benckiser, and Vodafone Group. I also like Tesco and Legal & General at current levels.
I reckon by adding proven businesses like these to my portfolio, I should be able to generate steady returns over the next few years, even if the outlook for markets remains uncertain.