Last year was a particularly strong one for the FTSE 100. It gained almost 7% and in doing so reached record highs. With its dividend yield of almost 4% added to its capital growth figure, the total return provided by the index was around 11%. That’s approximately 50% higher than its expected annual return.
Looking ahead, the index faces a number of political and economic challenges. Brexit is moving closer, global economic risks remain and the UK’s uncertain political outlook could cause investor sentiment to decline. However, with what seems to be a low valuation and a lack of appeal of other major asset categories, the FTSE 100 could rise yet further.
Low valuation
With a dividend yield of 4%, the index appears to be relatively cheap at the present time. This figure is towards the upper end of its historic dividend yield range and means that even though it recently hit an all-time high, there could be further upside ahead.
Compared to other global indices, the FTSE 100 also appears to be cheap. The S&P 500 has risen significantly more than its UK peer, gaining 18% in the last year. This means it has a dividend yield of just 2% at the present time. In theory, this could mean that the FTSE 100 could double before being as expensive as the S&P 500. As such, there could still be significant upside potential ahead.
Relative appeal
Shares could also continue to be popular due to their relative appeal versus other assets. For example, bonds may offer limited upside potential due to the prospects for a higher interest rate in future. While the Bank of England may decide to adopt a loose monetary policy in the short run, higher inflation and continued GDP growth may mean that a higher interest rate is warranted over the medium term. This could cause bond prices to decline as bond yields move higher to compete with higher interest rates.
Similarly, property remains a difficult asset in which to invest directly. Tax changes and the risk of void periods mean that many investors may wish to remain fully invested in shares. And with the availability of buy-to-let mortgages becoming less widespread, buying and renting out a property could become increasingly difficult.
Uncertain outlook
Of course, the FTSE 100’s future may be highly volatile. As mentioned, Brexit is only a matter of months away and political risk in the US and in the UK could cause investor sentiment to decline. However, this year could see further gains for the index due to its low valuation and its high appeal versus other major asset categories.
As such, now appears to be a perfect time to buy it – even though it is trading at a record high. While it will not make anyone a millionaire in the short run, in the long run it could significantly boost your portfolio’s performance.
