The FTSE 100 (FTSEINDICES: ^FTSE) trading at 8,000 may sound rather unrealistic for a lot of Foolish investors. Indeed, with the index currently at 6820, gains of 17% to reach 8,000 points may seem a little far-fetched. Certainly, the FTSE 100 has failed to deliver on its promise thus far in 2014, with the UK’s leading index up just 1% year-to-date.
However, 8,000 in 2014 is entirely possible and here’s why.
The FTSE 100 Is Relatively Undervalued
Although US and UK markets do not exhibit perfect positive correlation, they are very highly correlated. This means that upward and downward movements tend to be mirrored between the two indices, largely as a result of a high degree of globalisation and the ease with which investors can access both markets.
However, there appears to be a rather significant discrepancy in the current valuations of the leading US and UK markets. For example, while the FTSE 100 trades on a price to earnings (P/E) ratio of 14.1, the S&P 500 (which is the most relevant comparator, since it is weighted by market capitalisation, like the FTSE 100, and contains 500 stocks versus just 30 for the Dow Jones) trades on a P/E of 18.1.
That’s a substantial difference and, interestingly, is not mirrored in the current valuation of the FTSE 250. That index trades on a P/E of 18.8 and, if the FTSE 100 were to trade on the same multiple as the S&P 500 or the FTSE 250, it would currently be valued at around 8,750 or 9,100. Suddenly, 8,000 doesn’t look quite so out of reach!
High Exposure To Mining
Of course, there’s a plausible reason for the FTSE 100?s relatively undervalued status: a generous exposure to mining. Indeed, mining stocks such as Rio Tinto (Xetra: 855018 – news) and BHP Billiton (NYSE: BBL – news) have suffered from a slowdown in China and have undoubtedly subdued the wider index. However, despite Chinese growth being slightly behind target in the first quarter of this year, recent data from the world’s second largest economy indicates that things could be picking up, with the purchasing managers’ index being at its highest level for five months. Further positive news flow from China could help the FTSE 100 to move upwards.
A Low Interest Rate Environment
The Governor of The Bank Of England, Mark Carney, recently said he was in no rush to increase rates, while Janet Yellen, Chair of The Federal Reserve, is only just beginning to unwind the monthly asset repurchase programme. This provides support to the stock market, since investors know that if economic data does disappoint, then central banks are likely to step in so as not to jeopardise the wider recovery. Indeed, relatively low inflation provides the perfect excuse for further quantitative easing in the UK, which could increase asset and share prices further.
So, while the FTSE 100 trading at 8,000 points may seem a little far-fetched at first, a combination of central bank policy, improvements in emerging markets and, crucially, a narrowing of the current valuation discount could combine to push the FTSE 100 up by 17%. By this time last year it had risen by 13.5%, making the final seven-plus months of this year plenty of time to make the necessary gains.
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Peter owns shares in BHP Billiton.