The FTSE 100 seems to be entering crash mode as it plummets towards 6,000. In just the last month it’s lost over 10% of its value with no sign of a slowdown. Panicked investors everywhere are looking for an exit.
It is at times like these that a little reflection on history may be useful. In particular, reflection on the kind of valuations, dividend yields and so on, that the market has had in the past, which may illuminate, at least to some degree, what might happen in the future.
For example, could the FTSE 100 fall below 6,000? That seems likely as it has just fallen below 6,100 as I write; but what about 5,000, or 4,000? Could it really go that low?
In the last two major bear markets in 2003 and 2009 it fell as far as 3,500. Perhaps that 6-year pattern will be repeated in 2015?
Using Shiller’s CAPE as a guide to what might happen
Robert Shiller’s CAPE (Cyclically Adjusted PE) is a handy tool for producing reasonable guestimates of what might happen in the future, based on where we are today.
For example, at 5,000 the FTSE 100’s CAPE would be 10. If it fell to 4,000 then its CAPE would be 8 and at 3,500 its CAPE would be 7.
To give you something to compare those numbers to, in 2009, when the FTSE 100 stood at 3,500 and everybody thought the financial world was about to end, the market’s CAPE was 9.5.
So assuming the CAPE approach is correct, for the FTSE 100 to reach 5,000 investors would need to be as pessimistic as they were when we were days, or even hours, from a global financial collapse.
Currently, that seems a little unlikely.
Using dividend yield as a guide to what might happen
Alternatively, you could look at dividend yields.
The Capita Dividend Monitor expects total FTSE 100 dividends in 2015 to be around £85 billion, which equates to approximately 201 index points.
If that were correct then at 5,000 the FTSE 100 would have a yield of 4%. That’s high, but not unfeasible high.
At 4,000 the large-cap index would be yielding 5% and at 3,500 it would be yielding 5.7%.
For some context, the market was yielding about 6% at the very bottom of the financial market crash in 2009.
So from a dividend yield perspective, 5,000 looks quite possible, but would probably require bucket-loads of bad news. 4,000 may require something like a financial hurricane and to see 3,500 we would probably need to be on the brink of Armageddon (again).
As to how likely any of those scenarios are, your guess is as good as mine.
Selling in a bear market: The worst investment strategy in the history of mankind
And what if the FTSE 100 does fall to 5,000 or even 4,000? Would it then be time to sell?
Perhaps, but just think about what happened the last time the market reached those levels.
In late 2002 the market fell to 4,000 as investors everywhere ran for the hills, but within 3 years it had gained 50%. It reached 4,000 once again in 2008, after which it took barely 2 years to gain 50%.
So there is a pattern.
When the market falls dramatically, it’s unpleasant. But those investors who can endure the bumpy ride are usually rewarded, eventually, with exceptional short-term returns. On the other hand, investors who choose to get off the bus are often left sitting in the dust, going nowhere.
Thanks for the post, nice quick bit of context to help us consider where we could go from here.
As always, hindsight is a wonderful thing, but to be honest are any of us that surprised about what’s happening? Firstly it’s October, we’ve had no real volatility for a long time, QE in the US is ending, there are worries about deflation left, right and centre, people are jumpy about ebola, oil’s slumping, then the Shire deal gets called into question…
I’m not thinking of selling; I’m just wondering when’s the right time to buy more and which are the best bargains! And whether there will still be such opportunities by the time the next ISA year opens..
HI JAL, investors shouldn’t be surprised, but from quite a few recent conversations I think many are (overly) upset by the poor returns in 2014. It’s just super-easy for us humans to see the solid, steady gains of the last couple of years as ‘normal’, and to overreact when things go the other way.
John, Somewhat off topic I know, but it looks like your article on Rolls Royce is already bearing fruit. This morning it’s down at 866 and I’m still watching.
What’s your entry point to this quality company, given that it has now admitted it will struggle to grow in 2014 and now 2015 as well. The forward (2015) yield at this price is 2.9% assuming the growth in the dividend is maintained. Cash flow will halve this year.
LR.
Hi LR, well I’ve just run my screen again and Rolls Royce comes in at number 58 out of 236 companies in the All-Share that have a 10-year run of unbroken dividend payments, so it’s pretty near the top. At its current price I’d say it’s attractively priced, but not super-attractive.
In that previous article I said it would be interest at around 800p and it’s getting there, but remember that everything else has fallen since July as well! So now that things have moved on (or down, to be more precise), I think the shares would need to be at 700p before I’d invest.
But as I say they’re in no way expensive by my measures at 866p.
Mr Market seems to have migraines in the morning and he is throwing every day low prices in the market.
For me it was fun as I tripled my portfolio investing all the cash I had available and I borrowed a bit based on the December bonus which is not far away. I added quite a few UK small and mid caps, a couple of European stocks, a few US stocks and added to Japan Tobaccos.
RR is an interesting case, myself I believe the annual results will be better than expected, it depends a lot in the exchange rate as the majority of the products and services are sold in USD. I have 3% of my portfolio in RR.
In a rather twisted way I’ve been looking forward to a crash. I invest in index funds and was getting tired of buying higher and higher, so now look forward to buying more for less. I’m a long way from retirement and firmly believe the market will be higher in years to come.
Hi 30SD, that’s exactly right. If you’re going to be buying equities for a long time rather than selling then lower prices are better for you. Personally I’d be quite happy for valuations to stay low for years so that every pound reinvested is getting more bang for each buck, but even so it is emotionally unsettling to see market’s going nowhere. It’s a psychological quirk that most investors just have to live with.
Hi All
I may as well add my thoughts for what they are worth which probably is not much.
Its possible that the UK equity market could fall to a very low value like 3500 or 4500 but observing the past lows over the last dozen or so years it spent a lot less time at these depressed levels in 2009 than it did at 2003. It would take some time to get there , I guess about a year, and I doubt that it would spend much time there. If you look at the lows of 1974 it spent about 6 months at these exceedingly distressed levels.
RR – my price about 550 now. Should the price consolidate to about 700 in a few years then I would find it attractive.
Regards
Hi Ken, I’d be amazed if we got back to 3,500, but if we did it would truly be an opportunity of a lifetime, assuming it didn’t involve the collapse of society as we know it.
But as I read in a Buffett Biography once, he had a note on his desk or wall which read “In the event of a nuclear war, ignore this message”. In other words, buy on the way down on the assumption that the market will come back up, because if the market goes to zero you’ll have bigger things to worry about than your investments!
Dear Mr Kingham,
Sorry, but I have been and remain a growling bear. In fact I sold (at a market high) in May and went away and have been sitting on a pile of cash and a few bars of gold ever since. True, I have had to wait 5 months for the correction I feared to get under way and my actual and opportunity costs have not been negligible. However, they are nothing compared to the opportunity cost of an ability foregone to reinvest the same funds at the bottom of the market, no matter where of when that may be.
We will have to wait and see if the FTSE’s late rallies on Thursday and Friday amount to anything but, with stupendous levels of sovereign debt (on both sides of the Atlantic); irrational rock-bottom bond yields; asset prices all round pumped-up by QE funny money; the very real threat of deflation in the Eurozone; Abenomics juddering on the rails in Japan; a sharp slowdown in growth in China; continuing political friction in the far east; ISIL’s rape of the middle east; Islamic fundamentalism spreading in Africa; a messy and inconclusive outcome threatening at the forthcoming general election in the UK (plus inevitable rises in interest rates); continuing party political stalemate in the USA; and the Ebola epidemic now just getting an international foothold, there can be only one way that the markets will be trending for the foreseeable future.
I like and appreciate your considered approach to value investment. The problem is that it only works in a market that is generally rising and can be expected to continue to do so. In a market that is falling, that which looks good value today can suddenly find itself looking over-priced relative to the rest of the market tomorrow.
Sincerely,
GB
Hi Graham, thanks for commenting.
Generally I’m not a fan of market timing. I believe that markets are driven by news, which is essentially random otherwise it wouldn’t be news. That means markets, the macro-economy, corporate results and so on are, in the short-term, also largely random, and so I don’t like to place any large-scale bets (like being in or out of equities) on random events. I can easily picture alternate histories in which the ebola outbreak didn’t occur, the ECB had been more accomodative, that ISIL hadn’t gained traction, and where markets were confident enough that the FTSE 100 reached 7,000 this year and never, ever, saw 6,000 again.
But that’s just my opinion and I know that most people don’t think in terms of probabilities and alternate histories and futures. And of course there may be some people who can market time effectively – I’m just not one of them.
As for my investment approach, I would say let’s wait and see. The UKVI model portfolio, which is essentially a live experiment on and feedback mechanism for my strategy (in which I am also personally fully invested), has only been running for just under 4 years, which is a relatively short period of time. It hasn’t yet had to face a major bear market and so I cannot comment on how it does under falling and weakening conditions, although my expectation is for it to have less downside risk than the market. But the proof of the pudding will be in the eating.
It would be interesting to see the Top 10 ftse constituents weightings, pre and post past crashes.
2009 I presume, would have had a higher weighting of banks, which resulted in the market yielding 6% at the bottom. Those dividends ended up being cut.
I presume for the market to yield 6% today it would require a whole different crisis affecting a broader range of companies.
Hi Adam, yes that’s an interesting idea. In 2000 the market would have been very heavy in telecoms companies, and 2008 banks. So what are we heavily weighted in now? You can see the FTSE 100 constituents by market cap here:
http://shares.telegraph.co.uk/indices/
It doesn’t mention sector but most of them you can guess. Or this PDF…
http://www.ftse.com/Analytics/FactSheets/Home/DownloadSingleIssue?issueName=UKX
shows sectors. Oil & Gas = 17%, Banks = 14%, Personal & Household Goods = 10%, Healthcare 10%, Basic Resources 8%…
So that’s most of the market. Not sure how that compares to earlier times though.
I think for the market to yield 6% would just require very poor investor sentiment. So much money sloshes in and out of the market in one big lump because of index trackers now that I think general sentiment rather than stock specific sentiment is become ever more important. Good for stock pickers, bad for efficiency.
Hi John
Very interesting article, as always. As someone who has been dripping money into the stock market for just over a year now, with a view to generating long term dividend income prior to a radical change in lifestyle (with no other source of income) I cannot deny that I’m finding this correction as scary as hell but I’m trying hard to keep my emotions in check. I’ve taken the opportunity to invest in Glaxosmithkline and Centrica for the first time this past week, and I’ve topped up on Shell (RDSB). There are/were several other companies I almost bought into too, but fear of this correction getting worse has so far topped me. I will wait a little while to see what happens. I’m now about 55% in shares and 45% in cash.
Thank you for posting this article and thanks to the people who have replied too. Much food for thought. Looking forward to your next article.
Bill
PS – I would love to subscribe to your website to get full access but it’s looks like I need to hold on to every penny to make my change in lifestyle possible. Sorry 🙁
HI Bill, no need to apologise. If you can generate better returns with that £250 than you could by becoming a UKVI member then you’re better off keeping it yourself!
As for your stock selection, I own two of the three you mention so if you’re looking for relatively low risk and reasonable growth I’d definitely say you’re fishing in the right part of the river. And if you’re looking for long-term dividend income you’ll have to get used to ignoring share price volatility, so perhaps this little correction is a good training exercise…
Hello
Great article! Personally I view this as a buying opportunity. Yes there is some bad news out there, but the yield on the FTSE100 appears to compare favorably with other passive investments of similar risk in my opinion.
I have one question, you quote the FTSE100 yield as 201 index points. This is at odds with Investors Chronicle, which in its latest issue quotes a yield of 3.64% at 6392.68, implying a yield of 232.69 basis points.
Both cannot be correct, so where does the truth lie please?
Many thanks
Jon.
Hi Jonathan, thanks.
As you say the yield in index points is just the current price multiplied by the percentage yield, but my calculation is based on an estimate of the 2015 dividend via the Capita dividend monitor, whereas IC’s yield would probably have been calculated using the current, i.e. historic yield.
The dividend is likely to be lower in 2015 than 2014 because of the large one-off dividend from Vodafone in 2014, which won’t be (probably) repeated next year.
So both are correct, although the IC figure is more factually accurate as mine was based on a forecast figure, so they’re not quite apples and apples.
As for the FTSE 100 valuation, yes I agree it looks quite good value, certainly compared to the US market.
John
Many thanks for the response. I emailed the Editor of IC and you are absolutely right; IC quotes a trailing dividend yield.
May I ask, is your 201 index points forward yield the gross figure (I.e. including the 10% dividend tax credit) or the net figure, received in the bank account of the recipient?
Many thanks
Jonathan.
Hi Jon, the 201 figure is based on dividends paid out by companies rather than the amount received.
Including the 10% dividend tax credit, or excluding it please?
Thanks again,
Jonathan.
Just double checked… the Dividend Monitor says that it:
“analyses the latest trends in total gross UK dividend payments (before the 10% withholding tax)”, so it includes the notional 10% tax credit.
I have to be honest I am a bit of a bear myself. I only buy selected companies which I believe they will do well in the next 2-3 years time. I avoid cyclical stocks at this moment.
John, I do not think that the CAPE analysis in any better or worse than any other analysis to say if the market is cheap or expensive. It is hard to account for low investment rates.
Is UK better priced than US? I doubt, so my highest equity allocation is to the US. UK will go through elections next year, with incertitude around a referendum to stay in the EU and these will affect the share prices and more than that the firms reinvestments in UK. Given the proximity to Europe, we could go in recession similar with our neighbours.
In my opinion low interest rates are here to stay.
Graham, I was waiting for this blip for 15 months when I sold 70% of my portfolio. I have taken the contrarian view and invested some (I should have invested all) of those funds in medium and long duration investment grade bonds, in spite of some people announcing interest rates increases.
Bill_UK – you need an assessment of your risk profile and risk capacity. If you are fearful, your allocation to equity should be lower. Investments in bond are not bad at all, it may even outperform equities in the next three years. For a 7 years duration you get a 4.5% yield in investment grade corporate bonds. If interest rates stay the same, you collect the yield, if it gets lower you may get a little capital gain. If interest rates increase, you should make real profits in your equity allocation and it unlikely you will lose ‘real’ money on bonds. Let’s say the interest rates will increase by 1% and the yield curve will move parallel (quite unlikely, as probably the yield curve will become less steeper) you lose 7% and collect 4.5% yield, so you are left with 2.5% loss.