Don’t confuse price with value in the equity markets.
While many of its European counterparts closed down yesterday, the FTSE 100 rose for the sixth consecutive day, with the UK’s blue-chip index closing up 0.22 per cent and reaching 7,037.67. Shirking fears over Greece, which sent France’s Cac 40 falling 0.65 per cent and the German Dax tumbling 1.19 per cent, the FTSE 100 reached fresh all-time highs, surpassing its previous record close of over 7,000 on Friday.
Dominated by internationally-focused companies, its growth has been partly attributed to speculation over monetary policy. The Federal Reserve signalled last week that interest rates may not rise as quickly as previously anticipated, and the Bank of England has made similarly dovish noises. But some argue that the FTSE rally is based on solid fundamentals too.
In short, now that the FTSE has finally blasted through its former ceiling, analysts are divided over where the index’s rally will go next. Is it well-placed for more sustained growth?
A DIVIDED MARKET
“We are nervous of buying into a rally that is less about improved corporate earnings forecasts, and more about delving into the tea leaves of statements from the US Federal Reserve,” says Tom Elliott, international investment strategist at deVere Group. Indeed, he argues, massive central bank intervention over the past six years “has disabled financial markets’ ability to signal changes in the real economy.” For Elliott, these record highs are merely the result of speculation over the future path of ultra-easy policy – with the internationally-focused FTSE rising off the back of dovish signals from central bankers on both sides of the Atlantic.
But not all boats have risen on the rising FTSE tide. Weir Group, the Glasgow-based engineering group, saw its stocks fall 2 per cent yesterday, after analysts at Royal Bank of Canada downgraded their recommendation on the company. Carnival, the cruise company, also suffered after being downgraded by brokers.
Standard Chartered, meanwhile, soared after JP Morgan analysts suggested that the Asia-focused bank could relocate out of the UK in order to avoid the increased bank levy announced in the Budget last week.
Fundamentals or speculation? It’s a confusing picture, and it’s no surprise that traders are divided on the FTSE’s likely direction.
LONG OR SHORT
Data from eToro’s Openbook, a social network which monitors more than 4m users and measures their sentiment in relation to specific financial instruments, reveals that around 47 per cent of traders are short the FTSE 100, while 53 per cent are long.
James Hughes, chief market analyst at eToro, says that this is evidence of a fundamental difference of opinion on several key sources of uncertainty.
On the one hand, some investors are riding high off the positive effects of the European Central Bank’s huge stimulus programme. Eurozone QE is fueling expectations that the currency bloc, the UK’s main trading partner, will grow more strongly. Moreover, last week’s dovish Fed statements, which eased concerns over an earlier-than-expected rate hike, may have also helped boost sterling-based equities: “Since most of the world’s cross-border borrowing is done in dollars, it is good news for countries running trade deficits, such as the UK, and for companies seeking finance in order to expand,” Hughes says.
On the other hand, others are focusing on the Fed’s unclear path to raising interest rates, as well as the collapse of the euro. Despite a slight reversal since 12 March, the pound’s exchange rate against the euro is still over 4 per cent higher than two months ago, when the ECB first announced its bond-buying programme, which might make it harder for UK exporters to sell their goods abroad.
But on the whole, says Hughes, “there is a general feeling that equity markets have moved a little too far, too quickly and that a correction, especially in the German Dax, could be just around the corner.” Risk aversion, particularly over the renewed standoff between Greece and its creditors, may prompt traders to take profits, he says.
PRICE OR VALUE
For Matthew Jennings, investment director at Fidelity Worldwide Investment, however, recent record closes are beside the point and should not be used as a gauge of where the FTSE 100 will go next. “Don’t confuse price with value in the stock market,” he says. “Looking at price in isolation might be a tempting shortcut to assessing the stock market’s prospects, but digging a little deeper should prove more helpful to investors.”
In December 1999, for example, an investor in the average FTSE 100 company would have had to pay £30 for every £1 of earnings. The figure is just £16 for £1 of earnings today. “The assets you receive in return for the price are quite different and, on most measures, have significantly better value today,” he explains. Taking dividends into account (see chart) also paints a different picture to current concern over possibly over-hyped FTSE stocks. “The FTSE actually surpassed its previous peak by the end of 2005, and has continued to make new highs since then,” he says.
For shorter-term traders, Hughes expects the FTSE 100 to be a difficult play over the next week. Inflation numbers, released today, may be key. “Any good numbers will point to a potential hike, and anything weaker will point to a dovish stance,” he says. “The problem is the moves will be hugely exaggerated.” Indeed, with markets currently incredibly nervous, equities could easily start to unwind “at the smallest bit of market data”.