The FTSE 100 is the index that everyone loves to hate. It’s full of dinosaur companies from legacy industries like banking, utilities and commodities, and no self-respecting investor would touch it with a barge pole when they can funnel their cash into the much more glamorous and better-performing S&P 500 instead.
At least, that’s the mainstream narrative.
But there are a few hardy souls who still want to invest in UK stocks and FTSE 100 stocks in particular, and for those investors, monitoring the FTSE 100’s current valuation and forecasting its expected future price can be extremely useful.
Table of contents
- How did the FTSE 100 perform in 2023?
- Is the FTSE 100 expensive, cheap or somewhere in between?
- Where is the FTSE 100 likely to be at the end of 2024?
- Where is the FTSE 100 likely to be ten years from now?
How did the FTSE 100 perform in 2023?
To forecast the FTSE 100’s future we need to understand its past, so let’s begin with a quick romp through the index’s recent history.
After a surprisingly good 2022 (here's my FTSE 100 review for last year), where the FTSE 100 beat just about every other index on the planet simply by not losing money, 2023 was even better (at least on an absolute basis) thanks to a strong Santa rally.
Don’t get too excited though, because the FTSE 100 only gained 2% during the year. That’s better than the 1% it gained in 2022, but it’s still far behind the level of capital gains investors should reasonably expect in a typical year.
The chart below shows how the year was saved by Santa, and the red trend line shows how 2023 was another depressingly flat year.
Charts by SharePad
Of course, we shouldn’t be too surprised by the FTSE 100’s lacklustre performance in 2023. We did, after all, go through a (hopefully less than) once-in-a-century pandemic in 2020 and 2021, so it would be unreasonable to expect the UK economy or its stock market to be firing on all cylinders.
More importantly, equities are long-term investments, so while it may be entertaining to follow the FTSE 100’s ups and downs from one month to the next or even one year to the next, such short-term performance is essentially random and meaningless.
If you want to understand what’s likely to happen in the FTSE 100’s future, you need to look further back than 12 months or even 12 years. 25 years is a reasonable starting point and the chart below shows how the FTSE 100 has performed over the last quarter of a century.
The bad (and, quite frankly, embarrassing) news is that the FTSE 100 has gained barely more than 10% over the last 25 years (that’s 10% in total, not per year). That’s an annualised capital gain of just 0.5% per year over 25 years, which isn’t even enough to keep up with inflation. No wonder most investors have lost interest in the UK stock market.
However, if we can hold our nerve and look beyond the (admittedly horrendous) headline returns, the situation isn’t as quite bad as it first appears.
If you look at the chart above and squint, you should be able to see a gentle long-term upward trend buried underneath the shorter-term ups and downs. For the optically impaired, I’ve added a big red arrow to make this trend more obvious.
This trendline is important because it moves our attention away from the FTSE 100’s short-term price volatility and towards its underlying long-term growth, which is driven by the long-term earnings and dividend growth of the FTSE 100’s constituent companies.
The trendline is also important because it allows us to see when the FTSE 100’s price was far above or far below its long-term trend and, therefore, when the index was expensive or cheap.
For example, 1999 and 2007 were periods when investor optimism was high after multi-year economic booms, and that optimism drove the FTSE 100 far above its long-term trend. Alternatively, 2003, 2009 and 2020 were periods of deep pessimism for most investors and, uncoincidentally, that’s when the FTSE 100 was far below its long-term trend.
Last but not least, the trendline is important because it reminds us that what goes up eventually comes down, and what goes down eventually comes back up again. In other words, the FTSE 100 always returns to its long-term trendline, although sometimes it can take quite a few years.
If we take an even longer time horizon then the FTSE 100’s long-term upward trend becomes even more obvious. You can see this in the chart below, which covers the index’s entire history since its inception in 1984.
In terms of the long-term upward price trend, this 40-year chart is an improvement on the 25-year chart in every way.
The long-term trend is clearer, periods of marked overvaluation and undervaluation are clearer and the repeated reversion of price to the long-term trend is also clearer.
That FTSE 100 trendline goes from 1,000 in 1984 to about 8,000 at the start of 2024, which requires a growth rate of just over 5% per year.
That 5% growth rate is a good estimate of the underlying long-term growth rate of the FTSE 100’s constituents, in terms of their ability to generate profits and dividends (which, ultimately, is what investors are interested in). It’s also a reasonable estimate of the kind of long-term capital and dividend growth we should expect from the FTSE 100 in the future, as well.
Of course, whether we get that level of growth in any given year is impossible to know, but in the long term, 5% income and capital growth is a good baseline assumption.
Having said all that, in the medium-term, valuations can have a greater impact on returns than the long-term trend. This was clearly the case in 1999 (when high valuations led to deeply negative medium-term returns) and 2009 (when low valuations led to exceptionally good medium-term returns), so in addition to understanding the long-term trend, it's also useful to know where the FTSE 100 sits within its valuation cycle.
Is the FTSE 100 expensive, cheap or somewhere in between?
If you cast your gaze back to the previous chart, you’ll see that the FTSE 100, at 7,733 (on January 1st), is slightly below the long-term trendline, which ends at a nice round 8,000. The implication is that the FTSE 100 is close to but slightly below “fair value”.
However, rather than looking at the long-term price trend to infer long-term underlying profit and dividend growth, it’s better to go directly to the horse’s mouth and look at the FTSE 100's actual profits and dividends instead. We can then work out whether the FTSE 100 is cheap or expensive using tried and trusted valuation ratios like the price-earnings ratio (PE) and dividend yield.
One snag is that earnings are volatile from one year to the next, which can produce misleadingly high or low PE ratios. One common way to fix that is to use 10-year average inflation-adjusted earnings instead, giving us a cyclically adjusted PE ratio or CAPE.
The chart below shows the FTSE 100’s cyclically adjusted earnings and dividends since 1987 (note that dividends don’t need to be cyclically adjusted as they’re already far more stable than earnings).
These plots look similar to the long-term price trendline in previous charts, and that’s because the FTSE 100’s long-term upward price trend is driven by the long-term upward trend of its earnings and dividends.
Having said that, it's worth noting where these plots differ from the arrow-straight price trendline. The main difference is that the FTSE 100's cyclically adjusted earnings peaked in 2013 and have remained broadly flat ever since. The post-2013 earnings decline was caused by the global financial crisis and the end of the 2000s commodity super-cycle, which obviously hit the financial and commodities industries, both of which are major components of the FTSE 100.
More recently we've had the pandemic, but with those major setbacks fading into history, the chart also shows that the FTSE 100's earnings are finally returning towards their pre-2013 growth trend.
Turning back to the question of value, we can value the FTSE 100 using its price-earnings ratio (CAPE), which is shown in the following chart, along with the CAPE ratio’s estimated 100-year rolling average (the rolling average is estimated because the FTSE 100 only goes back to 1984, so before that, the FTSE 100’s CAPE is assumed to be the same as the S&P 500’s CAPE, where we have data going back to the 19th century thanks to Robert Shiller).
As you would expect, the FTSE 100 is considered expensive when CAPE is high and cheap when CAPE is low. This expectation matches reality, as CAPE peaked at 32 during the dot-com bubble and fell to a low of 9 during the 2009 global financial crisis.
The key point is that CAPE is mean reverting, so when CAPE is far above average, negative returns are far more likely, and when CAPE is far below average, strong double-digit returns are much more likely.
You can see from the chart above that today, the FTSE 100’s CAPE sits slightly below the estimated 100-year rolling average, at 14.8 versus an average of 15.8. The implication is that the FTSE 100 is currently trading slightly below fair value, which is essentially the same conclusion that came from looking at the long-term price trendline.
To illustrate how long-term earnings growth and valuation changes have impacted the FTSE 100 over time, here’s a FTSE 100 CAPE valuation chart that combines earnings growth and valuation multiples.
If you're not familiar with this chart, the rainbow’s path from left to right mirrors the growth of the FTSE 100’s cyclically adjusted earnings. The coloured bands indicate where the FTSE 100 would be if CAPE were at the levels indicated in the chart’s legend.
CAPE's historical range extends from about half to about double its long-term average, so the range extends from 8 to 32, with the centre of the yellow band showing where the FTSE 100 would be with a CAPE ratio equal to the long-term average of about 16.
Using this chart, we can see that in 1999 the FTSE 100 was at the very top of the “red zone”, indicating that the FTSE 100 was extremely expensive and that future returns were likely to be terrible (which they subsequently turned out to be).
Alternatively, in 2009, the FTSE 100 was deep into the dark green band at the bottom of the rainbow, indicating that the index was extremely cheap and that future returns would likely be extremely good (which, again, they were).
Here’s another version of the same chart, but with a more descriptive legend.
Unsurprisingly, this chart tells the same story as the price trend and CAPE ratio charts, which is that the FTSE 100 is currently trading close to but slightly below fair value.
So that’s where the FTSE 100 is today, but where might it be in the future?
Where is the FTSE 100 likely to be at the end of 2024?
CAPE is mean reverting because high and low CAPE ratios are driven by optimism and pessimism respectively, and neither optimism nor pessimism can be sustained indefinitely, so we should expect CAPE to return to its long-term average value (or fair value) at some point in the future.
Unfortunately, we cannot know when CAPE will return to its long-term average. It could take one year or it could take twenty years, but in either case, assuming that CAPE will mean revert is still the best option when forecasting future returns.
On that basis, what’s a reasonable forecast for where the FTSE 100 will be at the end of 2024?
Let’s start with the basics: Two factors drive price changes: (1) earnings growth and (2) expansion and contraction of the price-earnings ratio.
In terms of earnings growth, over the last 40 years, the FTSE 100’s cyclically adjusted earnings have grown at an annualised rate of 5.2%. Nobody knows how quickly the FTSE 100’s earnings will grow in 2024, so a simple and reasonable option is to assume that earnings will grow at their historically average rate of 5.2%.
As for price-earings (CAPE) expansion or contraction, the assumption is that CAPE will revert to its long-term average. CAPE is currently 14.8 and its long-term average is 15.8, so that implies an increase in CAPE of 7.2%.
If we multiply the assumed 5.2% earnings growth and 7.2% CAPE expansion, we get the following:
- FTSE 100 forecast for 2024: The FTSE 100 grows by 12.8% in 2024, leaving it at 8,725 by the end of the year
That all sounds very precise, but in reality, stock market forecasts are as imprecise as long-term weather forecasts in the UK. Even so, making a stock market forecast is still useful because it tells us where the FTSE 100 would be if investors were no more optimistic or pessimistic than they have been, on average, over the last 40-plus years.
Where is the FTSE 100 likely to be ten years from now?
As I never tire of pointing out, if you’re investing in equities then you should be focused on the long-term growth of earnings and dividends, not the short-term ups and downs of share prices.
So, while the preceding 2024 forecast is interesting and perhaps even somewhat useful, I think it’s far more useful and far more motivating to think about where the FTSE 100 might be ten years from now.
We can make a sensible forecast for where the FTSE 100 might be ten years from now on the same basis as the one-year forecast.
If we apply the same assumptions for earnings growth (5.2% annual growth of cyclically adjusted earnings) and price-earnings expansion or contraction (CAPE reverts to its long-term average of 15.8), we get the following:
- FTSE 100 forecast for 2033: The FTSE 100 grows by 80% over the next ten years, leaving the index at 13,800 by the end of 2033
Some will baulk at the idea that the FTSE 100 could reach almost 14,000 within ten years, but such an optimistic-sounding feat would require an annualised capital growth rate of just 5.3%. That’s effectively identical to the index’s growth rate over the last 40 years, and few investors would call the FTSE 100’s historical growth exceptional.
And let's not forget the small matter of the FTSE 100’s near-4% dividend yield. If we include those dividends in our return calculation (which we should), the FTSE 100’s total return forecast for the next ten years comes in at around 9% annualised, which most investors should be more than satisfied with.
Of course, in reality, optimism and pessimism will push the FTSE 100 either above or below that level, but given that we don't know how optimistic or pessimistic investors will be by 2033, 14,000 is still a sensible ballpark estimate for where the FTSE 100 could be.
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