The FTSE 100 has taken a plunge into the red. The index, at the time of writing, has experienced its largest one-day fall in four years due to fears about restrictions on trade and travel from China’s coronavirus epidemic. Many investors are in panic mode, dumping stocks and buying so-called safe-haven assets like bonds and gold.
However, the FTSE 100 had been climbing beautifully since 2016. Comprised of many quality companies, over time the index performed as expected. However, even good companies can be expensive and stock prices, like profits, cannot rise indefinitely.
Warren Buffett maintains stocks will outperform bonds
This reality reminds me of a recent comment by legendary investor Warren Buffett in his annual letter to Berkshire Hathaway’s shareholders this year. Buffett maintains that stocks are likely to outperform bonds in the long run, especially if corporate tax and interest rates remain low.
Fortunately, the UK Government has stated an intent to leave corporation tax rates as they are – at 19%. This is true at least for the short term. As for interest rates, the global savings glut shows no sign of abating, likely keeping long-term UK interest rates depressed.
Warren Buffett is known as the Sage of Omaha for a good reason. He’s proven himself to be an oracle when it comes to investing. In the very same letter he promoted stocks, he also warned that anything can happen to stock prices, including major drops in the market. Whether he was thinking about coronavirus, I don’t know, but his point illustrates that his title is well deserved.
You can’t forecast the future by extrapolating the past
Buffett says that you can’t forecast the future by extrapolating the past, and he would know. Therefore, a historic positive trend in the FTSE 100 is no evidence of a future one.
As importantly, recent demand for FTSE 100 stocks inflated their prices – but were the intrinsic values of the constituent firms growing to match? Or were these great companies simply becoming expensive?
Even great companies at inflated prices can become riskier investments. It’s likely that the high prices exhibited on the FTSE 100 recently became too much to bear for some investors once the market experienced the coronavirus shock. But a great company can survive short-term shocks, and a fair price can indicate a good buy.
A great company could be a steal at a lower price
The value of an investment is related to the price you pay. The lower the price, the greater the potential gain.
Now could be a good time to go shopping on the FTSE – there’s a sale on!
