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Is the FTSE 100 Facing Another Market Crash?

10 years on from the pre-crisis FTSE 100 high, we examine how UK stocks have fared over the past decade - and what investors should expect next

Emma Wall 12 June, 2017 | 11:41AM

 

 

 

Emma Wall: Hello, and welcome to the Morningstar series, "Ask the Expert." I'm Emma Wall and I'm joined today by Tanguy De Lauzon from Morningstar Investment Management to talk about the FTSE 100.

Hello, Tanguy.

Tanguy De Lauzon: Good morning, Emma.

Wall: So, this week marks the 10-year anniversary of the previous FTSE high before the following year we had a significant crash. And I was thinking about during that time and the difference between the sentiment then 10 years ago and the sentiment now. And the sentiment now seems to be this rally is very under-loved. People are waiting for the correction to come. But back then 10 years ago people were confident, people were liking the stock market and they certainly didn't see the crash coming, did they?

De Lauzon: Yeah, certainly. I think the situation was a bit different. I think at that time the economy was doing very well. I think emerging markets have had a brilliant period the previous years. Corporates were generally having very high earnings. And actually, probably that was the trick. I think corporates were doing so well, the earnings were so high at that time that when people looked at valuation signals like price-to-earnings ratio, it looked okay actually.

But if you looked at other valuation signals, probably like the cyclically-adjusted price-to-earnings ratio or price-to-sales or price-to-book, so looking at – whether looking at the recent earnings, looking at average cycle earnings, you would have found that valuations were quite higher at that time. But the situation was certainly a bit different.

Wall: And you spoke there about some warning signals. Were there ever other warning signals on the horizon that could have perhaps predicted what was to come, the global financial crisis?

De Lauzon: Yeah, I think, it's always difficult to predict a crisis. Almost by definition, if a crisis occurs, it's because it's unexpected. But you'd have, yeah, early warning signals. So, valuation is one typical signal that we would look at. I think market was also quite optimistic, sort of believed in the Goldilocks scenarios where everything happens and everything is going well. I think markets started to become a bit complacent as well about risk, about some of the financial innovations and that should be things that one wants to consider to assess the environment.

Wall: And so, what happened next? We had this high 10 years ago this week, but in the next couple of years were very difficult for investors, weren't they?

De Lauzon: Yeah. So, obviously a big crash in the markets. So, most equity markets down roughly by 50% over the next 18 months. Fortunately, for U.K. investors the pound crashed as well. For those who had foreign exposure, that was helpful. But basically, we had this big series of events culminating with the Lehman failure obviously. And so, it was a very tough period for a lot of investors.

But actually, for investors that remained with a long-term focus, really thought about their investment goals and that the investment goal should always be about the long-term, it was actually an okay period. Because if you consider 3.5 years after the peak you are back at the same level if you include dividends. And so, it's really a tough period for a few years, but for long-term investors it was actually possible to navigate through these difficult periods and to maintain investments. And 10 years after we're actually 60% above that level. So, it's close to 5% per annum. So, not a fantastic return, but something okay for someone who invested for his pension.

Wall: It's always easier said than done with that though because as we know through a lot of the behavioral science that we've studied here at Morningstar, when a crash comes, people tend to take their money out. They do panic. So, what can we learn from that experience, from the figures that you just told us, about the fact that the market now is looking similarly overvalued by a number of metrics?

De Lauzon: Yeah. So, I think that there's a few things to be prepared. You need to be prepared for this and you can't really think about what you're going to do as it happens. So, I think there are a few things, a few key investment principles that you need to have. And a few of the ones I would highlight is keeping that long-term horizon in mind, remaining focused on the long-term, that's very important. I think valuation is probably the most useful tool in terms of assessing where we are.

Looking at the fundamentals as well not only to assess what's the most likely scenario is, but what the range scenario is and trying to see whether there will be periods where the chances of positive scenarios are becoming slimmer and when actually the chances of a negative scenario, of a negative shock, are becoming larger.

And then the last I would highlight is to be independent-minded. In these periods all the press, all the media is very negative. You talk to your friends and families. They are very negative. And it's very difficult to keep calm, to control your emotions. But if you're able to do that, then you should stick with your investments in those periods and maybe actually there are some opportunity at offer to you to buy at very cheap prices stocks that are actually might be quite attractive.

Wall: Tanguy, thank you very much.

De Lauzon: You're welcome.

Wall: This is Emma Wall for Morningstar. Thank you for watching.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

About Author Emma Wall

Emma Wall  is Senior Editor for Morningstar.co.uk