UK markets are at a high right now. The FTSE is in the region of over 7,300.
At its peak in 2007, the FTSE was at 6,700. So it’s around 10% higher than that.
At the end of 1999, it was at nearly 6,800.
So that means one of two things:
- We are significantly overvalued and due for a crash. In 1999 you had the tech crash, and in 2008 the financial markets crash OR,
- History is not a reliable indicator of the future and something else is going on.
What are the reasons behind the current highs in markets?
Cheap money has flooded the economy for several years. Low interest rates mean that money doesn’t earn a return sitting in banks and so the price of everything goes up.
In the UK, the fall in sterling has meant that companies that make a lot of money in foreign currency see higher earnings, and that has given a boost to the FTSE in particular, where about 70% of income is from outside the country.
If you look at fundamentals, you might think that the underlying economy remains weak. There is a problem with productivity. Increases in earnings are starting to lag the increase in valuations.
Are we due a crash?
Some people don’t think so. Not yet anyway.
Although the UK market is at a high, with the price/earnings ratio of the FTSE 100 at around 30, the Cyclically Adjusted Price Earnings (CAPE) was around 14 at the start of the year.
The high PE is partly because many partipants had poor earnings last year.
The CAPE is supposed to be a better indicator of what is happening over a cycle and at 14 (20 in Q4 2016).
Robert Schiller, the Nobel prize winning inventor of CAPE argues that from this level, stock prices could still perform strongly for a few years.
If markets have been distorted over the last 10 years because of QE, then perhaps we can’t take current highs as a signal of overvaluation and there is still plenty of room for markets to rise.
So what could happen now?
It’s been 10 years since the last crash. This time 10 years ago, we didn’t know that markets were going to blow up the way they did.
We knew that certain markets looked like they were good value and made particular decisions about them.
Some decisions were never made. Investments on autopilot simply carried on regardless of market conditions or opinion.
We don’t really know much more this time around. Markets could go up higher. They could crash.
And some markets look like they could be good value.
In his 2016 shareholder letter, Warren Buffet set out what he hoped to do.
He had no plans, he said, other than to “dream big and be prepared mentally and financially to act fast when opportunities present themselves”.
And here is the important bit, given where we are right now as an economy and with BREXIT around the corner.
“Every decade or so, dark clouds will fill the economic skies, and they will briefly rain gold. When downpours of that sort occur, it’s imperative that we rush outdoors carrying washtubs, not teaspoons.”