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FTSE breaks 7,000 for first time…but it is Yellen not Osborne the markets are cheering

Although the Chancellor of the Exchequer will undoubtedly be pleased if the UK voters perceive the news that the FTSE 100 has ended the week on a new high as a resounding vote of confidence in this week’s Budget and his stewardship of the economy, the reality is that the latest spike in the market has little to do with domestic factors.

It is more a result of the mighty US Federal Reserve’s latest guidance this week that has reduced expectations of a tightening of US monetary policy. For now, recently mounting concerns over the removal of liquidity on global markets have abated and the heat has been taken out of the dollar rally. The good times of easy money are set to roll-on for a little longer, which has provided a relief to markets.

It’s important to once again reiterate that the level of the FTSE 100 is not in itself a particularly useful way of measuring whether equities are cheap or expensive. The index represents the combined market capitalisation (size) of its constituents and therefore an increase in the index can reflect companies having genuinely grown over time, as well as new major international firms having joined the index.

There are numerous ways to try and assess the value of shares, but the most common one is a measure called the Price/Earnings (P/E) ratio. This measures a share's price relative to the annual profit earned per share. In 1999 at the height of the dot-com bubble, the FTSE 100 was on a P/E of 27 times earnings, in large part due to very high ratings of technology and telecom companies, whereas now it is just below 16 times earnings. Current UK valuations are a little higher than the long term average but they aren’t astronomical either and certainly below those of US equities where the S&P 500 index is on 20 times earnings.

When drawing comparisons between the UK stock market now and at the peak of the dot-com bubble in 1999 it is also vital to factor in the impact of inflation over the last 15 years. We estimate that once adjusted for inflation, as measured by the UK Consumer Prices index, the FTSE 100 index would currently need to be at around circa 9,500 points to be comparable with its 1999 peak of 6,930 points. That’s a long way off where we are now.

The value of your investment can go down as well as up, and you can get back less than you originally invested.

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