The fall in the FTSE 100 of 3% on Tuesday showed that investor sentiment can quickly change. Investors have responded negatively to the potential for higher global inflation, and the possible interest rate rises that could come with it. As such, a number of stocks are now trading on lower valuations, and this could present a buying opportunity for the long term.
Of course, further falls could be ahead in the short run. Investors are currently in the process of adjusting their expectations for the global macroeconomic outlook. While interest rate rises had been expected over the coming years as the US and Europe gradually begin to feel greater inflationary forces, recent data from the former suggests that higher inflation may be coming sooner than expected.
The response of policymakers could be to increase interest rates at a faster pace. This may curb higher inflation, but may also reduce the amount of economic activity since it will be more expensive for businesses and individuals to borrow. And with other interest-producing assets such as bonds likely to see their yields rise in tandem with interest rates, stocks may even become less popular among investors.
While interest rates rises could be ahead, the reality is that the world economy is performing well. It is expected to continue to do so over the medium term, and this means that a number of global stocks could generate rising profitability in future years. As such, rather than the fall in the FTSE 100 causing investors to become less optimistic about the future for their investment portfolios, it may create opportunities to buy low and sell high.
Furthermore, shocks such as the 3% fall in the index on Tuesday are events which do happen occasionally in the world of investing. Investors tend to move quickly and together, which exacerbates the price movement in one direction or the other. For long-term investors, such moves are largely irrelevant - except when looking to add to their portfolios.
While a higher interest rate would make income-producing assets more attractive and stocks less so, the reality is that shares appear to offer the best risk/reward ratio of the major asset categories. For example, the FTSE 100 has a dividend yield of 3.9%. This suggests that it offers good value for money, since it is towards the upper end of its historic range.
Furthermore, with the prospect of total returns of 7%+ in the long run based on its historical performance, there are few other assets which can compete with the FTSE 100 in terms of return potential. And with it being highly diversified, the index appears to offer strong investment potential for the long run.
Although volatility may be high in the coming months, seeking buying opportunities following dips in the index's price level could be a sound strategy to adopt.
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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. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.