Last Updated July 21, 2015
The FTSE 100 seems to be entering crash-mode as it plummets towards 6,000. In just the last month it’s lost over 10% of its value with no sign of a slowdown. Panicked investors everywhere are looking for the exit.
It is at times like these that a little reflection on history may be useful. In particular, reflection on the sorts of valuations, dividend yields and so on, that the market has had in the past which may illuminate, at least to some degree, what might happen in the future.
For example, could the FTSE 100 fall below 6,000? That seems likely at it has just fallen below 6,100 as I write; but what about 5,000, or 4,000? Could it really go that low?
In the last two major bear markets in 2003 and 2009 it fell as far as 3,500. Perhaps that 6-year pattern will be repeated in 2015?
Using Shiller’s CAPE and as a guide to what might happen
Robert Shiller’s CAPE (Cyclically Adjusted PE) is a handy tool for producing reasonable guestimates of what might happen in the future, based on where we are today.
For example, at 5,000 the FTSE 100’s CAPE would be 10. If it fell to 4,000 then its CAPE would be 8 and at 3,500 its CAPE would be 7.
To give you something to compare those numbers to, in 2009, when the FTSE 100 stood at 3,500 and everybody thought the financial world was about to end, the market’s CAPE was 9.5.
So assuming the CAPE approach is correct, for the FTSE 100 to reach 5,000 investors would need to be as pessimistic as they were when we were days, or even hours, from a global financial collapse.
Currently that seems a little unlikely.
Using dividend yield as a guide to what might happen
Alternatively, you could look at dividend yields.
The Capita Dividend Monitor expects total FTSE 100 dividends in 2015 to be around £85 billion, which equates to approximately 201 index points.
If that were correct then at 5,000 the FTSE 100 would have a yield of 4%. That’s high, but not unfeasible high.
At 4,000 the large-cap index would be yielding 5% and at 3,500 it would be yielding 5.7%.
For some context, the market was yielding about 6% at the very bottom of the financial market crash in 2009.
So from a dividend yield perspective 5,000 looks quite possible, but would probably require buckets of bad news. 4,000 may require something like a financial hurricane and to see 3,500 we would probably need to be on the brink of Armageddon (again).
As to how likely any of those scenarios are, your guess is as good as mine.
Selling in a bear market: The worst investment strategy in the history of mankind
And what if the FTSE 100 does fall to 5,000, or 4,000? Would it then be time to sell?
Perhaps, but just think about what happened the last time the market reached those levels.
In late 2002 the market fell to 4,000 as investors everywhere ran for the hills, but within 3 years it had gained 50%. It reached 4,000 once again in 2008, after which it took barely 2 years to gain 50%.
So there is a pattern.
When the market falls dramatically, it’s unpleasant. But those investors who can endure the bumpy ride are usually rewarded, eventually, with exceptional short-term returns. On the other hand, investors who choose to get off the bus are often left sitting in the dust, going nowhere.