As I write, the UK’s FTSE 100 Index has just broken through the psychologically important 7,000 level to close at an all-time high. Great news, yes? Well…
One reason the FTSE 100 has done well lately is that sterling has been very weak, which boosts the overseas earnings of the United Kingdom’s large multinational companies. Two things to bear in mind about that currency weakness:
- It’s a result of Brexit, which is still casting a great deal of uncertainty over the UK economy;
- Sterling weakness has also enhanced returns from overseas markets – one good incentive for globally diversifying your investments.
And another thing: beware of talk of “psychologically important” levels in stock markets. Seven thousand is no more important than any other number, and people who say it is are suffering from a well-known behavioural bias called anchoring. The market is not automatically better valued at 7,000 than it was at 6,500.
The value of the market depends on a wide range of factors, including the outlook for company earnings. As I already mentioned, overseas earnings are currently being boosted by a weak pound. But will that continue? And what about domestic earnings against a backdrop of economic uncertainty?
People who say they know the answers to these questions may be suffering from another behavioural bias: over-confidence.
The truth is that I don’t know what the outlook for sterling is, and I don’t know what domestic or overseas earnings are going to look like in six or twelve months. And I certainly don’t know what investor sentiment – the other great driver of stock market valuations – will be doing as we navigate Brexit and beyond.
So, is it great news that the UK’s FTSE 100 is above 7,000? Maybe, and maybe not. And considering that uncertainty, I’d rather stick with a globally diversified portfolio of equities and bonds.