A historic day, Tuesday, as the FTSE 100 broke through both its closing and intra-day highs set way back on the 31st December 1999 at the height of the tech-boom.
To many this may seem to be an important milestone, but in reality, and speaking as a former stockbroker who was watching the madness of the tech boom unfold from the coalface; I think not so much.
Firstly, as the bulls will correctly point out, on a total return basis the FTSE is now well ahead of its level in 1999. Bears will also point out, correctly, that adjusting for inflation over that period the value of the FTSE 100 is well below its 1999 level. Indeed netting the two off, the FTSE 100 essentially hasn’t actually done very much over the ensuing period, apart from give us all some heart stopping moments of volatility.
There are also some key differences from 1999, the core being the Price Earnings Ratio (or PER), which although highish at around 16 (14-15 is preferable), is actually much, much lower than 1999 when it traced up to just shy of 30, which indicates we a massive crash seems less likely. However this misses the point that average PER’s, which are weighted by market capitalisations bias the number to whatever the biggest stocks are doing.
Back in 1999 just as tech companies could have PERs of 40, 60 or more, old tech companies, such as engineers, brewers, chemical companies could be had on single digit ratios. Indeed it was very possible to build old tech portfolios that GAINED 30% from 99/2000 through to the Bear market Lows of 2003, while the FTSE 100 fell by around 50%. Really; I know, as I did.
Right now that contrarian approach isn’t really possible, as a number of the largest FTSE constituents are, justifiably, on low valuation multiples are dragging down the average PER, while the stocks you want to own, whether in sectors you think will grow strongly (growth stocks) or solid, well financed, high income paying, strong franchised, brand leaders (quality stocks) are actually very expensive, on much higher valuations, pricing in growth we think unlikely in the increasingly deflationary environment now unfolding.
Basically there aren’t many opportunities to find value among large companies, a trend in part reinforced by the growing siren calls of passive investing, which leads investors to buy a basket of all the stocks in the index. Combined with QE, which we have shown to be largely detrimental to real economic growth but positive for asset markets, we have an environment that is increasingly hostile to anything resembling value investing.
This is not to say markets won’t rally further from here, just that for many investors being very bullish at these levels is a leap of faith, based upon hope and pretty simplistic analysis. However if you are prepared to look at smaller companies, especially the very small, there are still exciting opportunities, where the big name funds and all the index trackers can’t look.
The biggest worry investing at the smaller end is what happens if the overvalued larger stocks sell off and how will this impact smaller companies if market liquidity dries up? Nonetheless if you can look to the long term, and assume we are not about to enter a “dark ages” recession we think investors can still find opportunities, whatever the headline market numbers are doing.
Question is will the markets crash back? Our biggest worry remains the US so the following post will go through a few charts that put our worries into pictures