Investing in the stock market may seem to be a somewhat risky strategy at the present time. After all, the FTSE 100 has declined by around 15% since reaching an all-time high in May 2018. The FTSE 250, meanwhile, has fallen even further during that time, with its UK focus likely to have counted against it as a result of the political and economic uncertainty that seems to be mounting ahead of Brexit.
However, the two indices may now offer better value for money than they have done for a number of years. Compared to other mainstream assets, they could deliver stronger returns over the long run.
Clearly, falling share prices mean that valuations are lower now than they were in May 2018. The FTSE 100 and FTSE 250, though, were not particularly expensive eight months ago. As such, their recent declines have meant that they now appear to offer wide margins of safety that could make them appealing from a value investing perspective. For example, the FTSE 100 has a dividend yield of around 4.7%, while the FTSE 250 has a yield of around 3.3%. Both of these figures are historically high and suggest that there may be a number of good value opportunities on offer across both indices.
With the potential for increasing volatility over the coming months, owning stocks which have sound fundamentals could become increasingly important to investors. For example, low debt levels may help to reduce overall risk, while a track record of strong performance during periods of sub-optimal operating conditions could become increasingly attractive. This does not necessarily mean that defensive shares are more appealing than cyclicals though. The fall in stock prices could mean that the latter, when backed by strong balance sheets and sound strategies, now offers significant reward potential in future years.
While the stock market may deliver heightened volatility over the short term, in the long run it seems likely to outperform other mainstream asset classes. A forecast increase in interest rates over the next few years means that bonds may continue to lack appeal. Tax changes to property investment may also reduce its profitability at a time when house price growth is sluggish. And with inflation being above interest rates, cash continues to offer negative real returns.
As such, a diverse mix of shares in the FTSE 100 and FTSE 250 is where I would invest £5,000 today. Some international exposure may be sensible, since Brexit remains a known unknown. However, given the low valuations on offer from many UK-focused stocks, Brexit could prove to be a buying opportunity for long-term investors. In some cases, investors may already have priced in further potential difficulties among UK-focused stocks.
With a number of mid and large-cap shares offering sound balance sheets, low valuations and track records of profitability in difficult operating conditions, today may be a good time to invest. Further pain may be ahead in the short run, but continued declines could provide an opportunity to buy high-quality stocks at low prices.
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