The Year 2016 Will Belong to the FTSE 100

2013 has undoubtedly been the year of the Nikkei. The index was off the radar for most investors for several years, but when the Bank of Japan surprised everyone by unleashing a massive stimulus, the Nikkei transformed from mere sideshow to rising star. Boosted by a healthy dose of stimulus, the index surged by more than 50% in the space of twelve months.

Now, on the cusp of entering 2016, the FTSE 100, which has also been largely off the radar, is set for the same surge, leaving all other indices in the rear-view mirror. Sounds far fetched? Here are the reasons.

What Hit the FTSE 100?

The FTSE 100 has been lagging behind many of its peers in the developed nations, whether it’s the S&P 500 in the US or the DAX in Germany.
So why has the FTSE 100 been trailing behind its peers?

Unlike the ECB or the BoJ, the Bank of England hasn’t been adding enough stimulus to the economy, despite low inflationary levels.

This has led UK investors to become overwhelmingly defensive, preferring UK gilts (government bonds) to long bets on the FTSE 100. As can be seen below, from data compiled by Blackrock iShares, UK gilts have outperformed the FTSE 100 by 14.5%, surging 8% on average for the past year, while the FTSE 100 lost 6.5%.

Why Everything is About to Change 

So what is changing? Why is the FTSE 100 poised to catch up with its peers, just as the Nikkei did back in 2013? Because just as the BoJ added enough stimulus and eventually bowed to pressure as inflation plunged, so will the Bank of England.

The latest data shows that UK inflation has taken another plunge, and is on the fast lane to deflation (negative inflation). Not only that, but every time the ECB adds more stimulus, it pushes the euro lower and makes Eurozone products cheaper.

This essentially means that with every stimulus package, the ECB is exporting the Eurozone’s problems to the UK. With Mario Draghi set to unleash another round of stimulus, it’s only a matter of time before the BoE will be cornered and eventually forced to follow suit with its own quantitative easing, to fend off the deflation coming from the Eurozone.

How High Can the FTSE Surge?

Now you may wonder – once the BoE is indeed forced into unleashing stimulus – how substantial the FTSE 100 upside could be. The key is valuation.

That’s right – we have to dive into the fundamentals, into the actual valuations of companies under each index, and see how much FTSE 100 companies are undervalued compared to their peers under the S&P 500 or the German DAX. The simplest and perhaps most indicative method would be to compare the average price to earnings ratio for each index. ‘Price’ being the price of the index, and ‘earnings’ being the aggregate earnings of all the stocks under the index.

As we can easily see in the chart below, data taken from CNN Money and iShares shows a staggering picture. While both the German DAX and the S&P 500 are trading at a price to earnings ratio of about 20, the FTSE 100 is trading at just 10. A jaw-dropping 50% discount over its peers.

Rally May Come Out of the Blue

Of course, there are no sure investments in the stock market, FTSE 100 included. And that might tempt the average investor to think about waiting for the BoE to actually add the stimulus before jumping on the FTSE 100 rally. But that could be a big miss. Because back when the Nikkei rally began, stimulus was mere speculation, as that’s how markets work. The combination of the low valuation of the Nikkei and the speculation of stimulus made a fertile ground for the Nikkei’s remarkable lift-off. When weighing up the FTSE 100, it seems as though the fertile ground needed for a lift-off might already be there.
Published on Oct 2, 2015
By Nikolai Kuznetsov

Copyrighted 2016. Content published with author's permission.

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