Will the FTSE 100 rise or fall by 20%?
Predicting the performance of the FTSE 100 is always challenging, but right now it's more difficult than ever. That's because as well as the economic risk it faces, political risk is also exceptionally high.
One component of this is Brexit. Already there's uncertainty as to what 'Brexit' actually means and there are a huge number of unanswered questions regarding the UK's deal on areas such as immigration and trade with Europe and the rest of the world. This lack of clarity on the UK's long-term future is likely to only increase in the coming months since demands from businesses, individuals and foreign countries on how the UK will operate in 2019 and beyond will probably become stronger.
This is likely to have a detrimental impact on the FTSE 100. The business world naturally adopts a boom and bust cycle so that there are periods of under-investment due to concerns about future growth, while during growth periods companies often invest more than proves to be affordable.
The likelihood is that the next couple of years will be a period of under-investment in the UK economy, since no business favours uncertainty and that's what the UK is likely to experience an increasing amount of in future.
The political risk facing the FTSE 100 is heightened by the US Presidential election. Neither candidate is a clear favourite at this stage and should investors become concerned at the policies being introduced by the next president, a more risk-off attitude could dominate. This would be likely to cause an economic slowdown of sorts as well as a flight to safety, which would hurt the FTSE 100's future performance.
The FTSE 100 is currently just 3.3% off its all-time high. This price level doesn't appear to factor in the political risks the index faces, as well as the likelihood of further US interest rate rises. The Federal Reserve is due to raise rates in the next year and this is likely to cause uncertainty as well as a potential slowdown (to a degree) of the US economy.
Allied to this is the forecast for flat growth in the UK economy in 2017 as well as a rise in the unemployment rate of around 0.5%. The eurozone continues to grow at a snail's pace (as evidenced by 0.3% growth in the second quarter), while China's transition to a consumer-led economy won't be a perfectly smooth one.
Due to the above, the FTSE 100 could easily shed 20% in value over the medium term. Should this be the case, it could prove to be a superb buying opportunity for long-term investors. Even at its current level, the FTSE 100 offers good value as demonstrated by its 3.5% yield and mix of high quality stocks trading on fair valuations. Therefore, the best course of action could be to buy now, but keep some cash back in case the problems facing the FTSE 100 cause its short-term performance to suffer.
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Peter Stephens has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.