Has The FTSE 100 Index’s Current Valuation Discounted Brexit And Recession Risks?

FTSE 100 index is a portfolio of 100 large-cap companies by market capitalisation listed on the London Stock Exchange. The index is also considered as a benchmark of global stocks which are headquartered in the UK. Some of its major constituent companies are Royal Dutch Shell Plc (RDSA), Unilever Plc (ULVR), HSBC Holdings Plc (HSBA), BP Plc (BP), BHP Group Plc (BHP), AstraZeneca Plc (AZN), GlaxoSmithKline Plc (GSK), Diageo Plc (DGE), Rio Tinto Plc (RIO), Reckitt Benckiser Group Plc (RB) and Vodafone Group Plc (VOD). These major constituents of the broader index of the UK are more global companies rather than just UK stocks, which makes this index a global benchmark. Sectors which weigh higher on the index in terms of market capitalisation are Oil and Gas (20.3%), Financials (18.14%), Consumer Goods (17.5%), Basic Materials (11.74%) and Consumer Services (10.56%) respectively.

Index Trading Summary

At the time of writing, the index was quoting at 7,338.03 and added 70 points or 0.96% against the previous trading session. In the year-ago period the index has registered a 52-week high of 7,727.49 as on July 30, 2019, and a 52-week low of 6,599.48 as on January 02, 2019, respectively. Its lifetime high stands at 7,903.50, touched on May 22, 2018 and lifetime low at 986.90, touched on July 23, 1984 market session.

On a Y-o-Y basis, the index has delivered a price return of 0.89%, on a YTD basis the index was up by 9.06%, and on a quarter-to-date basis, the index was down by 1.18% respectively.

How does FTSE 100 offer more value than its global peer indices like the S&P 500 and Nasdaq Composite Index?

Despite the FTSE 100 index representing a portfolio of global stocks, it has not much participated in the recent bull rally against its global peer indices. In the past five years, the broader index of the United States, the S&P 500 index, has surged with a compounded average growth rate of 8.25% and Nasdaq Composite Index has delivered a Compounded average growth rate of 12.0%; whereas during the same time span, the FTSE 100 index has delivered a CAGR return of 2.3%, which is substantially lower than that of its global peers.

Also, from a valuation standpoint, the broader index of the UK was trading at a price-to-earnings ratio of 14.5x whereas the broader indices of the United States, the S&P 500, was quoting at a price-to-earnings ratio of 20.45x and the technology benchmark index, the Nasdaq Composite index, was trading at a Price-to-Earnings ratio of 23.10x, all of which reflect that the FTSE 100 index is trading at a lower valuation against its peers. Also, the average dividend yield of the FTSE 100 index stood at 4.64% whereas the average dividend yield of the S&P 500 index stood at 2.39%, which reflects the FTSE 100 index trading at a lower valuation against the global peer indices with substantially higher dividend yield. The above-discussed valuation and dividend yield makes FTSE 100 index more lucrative from an investment point of view.

However, ongoing market challenges related to trade spat between the world's two largest economies, the United States and China, has jolted the sentiments of the investment community globally and has led to increasing investments in safe-haven asset classes like Bond, Gold and Yen, Resulting in lower bond yields. Recently the 10Yr. Bond Yield sent some classic signals of slowdown as the short-term bond yield was higher against the long-term yield, which indicates that investors are assuming higher risk in near-term and that’s why they were demanding higher risk premium on short-term bonds as compared to long-term bonds.

However, while many investment analysts are predicting a slowdown in near-term, that the depth of the next recession will be the same as witnessed during the 2008 financial crisis is somewhat questionable. Because 2008 crisis was more to do with mortgage-backed securities, in which housing loans were bundled into different financial products and transferred across the markets and those who were just passing on these products had no accountability. What emerged as a global meltdown started in the United States and then engulfed UK, Ice Land, Dubai and other many other developed countries and many blue-chip banks and financial institutions went bankrupt.

But this time, it's going to be different, and depth will not be at par with the 2008 crisis. Also, if we through some light on the origins of past recession, which mostly originated in the United States, this time many predict that it is going to be made in China, with its humongous amount of debt and softening economy, in the wake of ongoing trade war, which is going to hurt the country substantially.

The stock market in the United Kingdom is already witnessing headwinds because of Brexit related uncertainties, which didn't let UK stocks to participate in the previous rally. So it has undeformed against the other global equity benchmark indices and therefore we may not see a steep correction in UK stocks as they have not participated in the previous bull cycle. Well, there could be some contagion that could take place, but the depth will be substantially different from that of its global peers.

Despite jolted investment sentiment, the stocks in the United States and other developed economies are trading at a valuation which doesn't seem to be sustainable and investors are not opening their purse strings at this higher valuation and are waiting for a correction to take place. The stocks in the UK are trading at a discounted valuation against the peers which makes it more lucrative from an investment point of view.

Also, the FTSE 100 constituents' stocks are more global stocks, and if someone invests at this valuation with higher dividend yield, he is not buying only UK stocks at a cheaper valuation but is getting global stocks at a lower valuation. The majority of the FTSE 100 companies source a large share of their income from the overseas.

And, the current dividend yield of the FTSE 100 index, which stood at 4.64% is approximately 1.9 times of the S&P 500 dividend yield of 2.39%, around 2.7 times the US 10 Yr. Bond yield and 7.16 times the 10Yr. yield of 0.649% of UK government treasury bond. Which makes the FTSE 100 index's stocks more lucrative from an income perspective. Also, it is getting support from falling Pound Sterling against the US dollars, with currency transition benefiting most exporting companies.