One of the difficulties of investing is going against the herd. At the present time, for example, many investors are fearing further declines for the FTSE 100 after it has lost over 10% of its value since reaching an all-time high in May.
However, history shows that the index has always recovered from whatever challenges have been thrown at it, whether that is a financial crisis, technology bubble bursting or commodity crisis.
As such, it seems likely to overcome the current risks it is facing. And in the meantime, buying high-quality shares with strong balance sheets at low valuations could prove to be a sound move.
Clearly, the FTSE 100 has not shed over 10% of its value within six months without good reason. There are a number of risks facing the world economy. Since three-quarters of the index’s income is derived from outside of the UK, issues such as rising US interest rates and their potential impact on emerging markets could have a negative effect on profitability for a number of businesses. Similarly, tariffs on imports may be yet to have their full impact, but could lead to a slowdown in global GDP growth.
Alongside this, the UK political and economic outlook remains relatively fluid. This could cause significant volatility in the value of the pound. In turn, this could lead to further swings in the price level of the FTSE 100, since many of its incumbents report in GBP but operate mostly in international markets. As such, there could be a period of further declines in the near term which causes the index to move even lower after a tough six-month period.
As mentioned, the FTSE 100 has always recovered from previous falls. Therefore, if an investor buys shares in a declining market and experiences paper losses, this situation could be reversed over the long run. In fact, even at a price level that is within 10% of its all-time high, the index does not appear to be overvalued in my opinion.
It has a dividend yield of around 4%, which is relatively high compared to its track record. And since a range of its constituents offer significantly higher yields, as well as low price-to-earnings (P/E) ratios, there could be a number of stocks trading at a discount to their intrinsic values. A buying opportunity may therefore exist at the present time for long-term investors.
But things could get worse before they get better. Risks such as a rising US interest rate, tariffs and Brexit may cause investor sentiment to worsen. But with what seems to be a relatively low valuation, buying FTSE 100 shares with strong balance sheets and sound business models could prove to be a profitable move in future years. And since the index has a track record of recovery, its risk/reward ratio appears to be relatively appealing at the present time.
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Peter Stephens has no position in any of the 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.