Volatility can’t keep the FTSE down for long
THE UK equity market has lacked a champion of late, but analysts at UBS are taking up that mantle. They argue that the FTSE 100 will end the year at 6,250, about 1,000 points above its current level.
But the road toward a higher FTSE will not be smooth. Stress test results for the European banking sector, sovereign debt problems in Southern Europe, austerity budgets and fears of a double-dip are likely to keep volatility high. UBS also predicts that the UK index will trade in a wide range from 4,280 to 6,250 until the end of the year.
There are some compelling reasons to buy UK stocks if you have the stomach for it. The UK Shiller price-to-earnings ratio, which measures if stocks are cheap or expensive, is firmly in buy territory. Stocks also look attractive relative to gilts. The 12-month forward dividend yield on the UK equity market is just short of 4 per cent – even after BP suspended its dividend last month – well above the yield on 10-year bonds, which is currently 3.34 per cent.
Using historical data, UBS has found that profit growth should remain strong for the next couple of years. It argues that when a profit cycle turns in the UK, as it did last year after a slump in 2008, the cycle tends to last for five years. This is good news for equity prices.
But what should investors do? Structured products are a good option if you want to limit your downside risk. RBS offers covered call warrants that expire on the 16 December with a strike price of 6,000 or 6,500 and the maximum you can lose is your initial investment. However, they can be expensive if volatility is falling, as it is right now: the Vix index has fallen from a high of 45 in mid-June and was trading at 24 yesterday.
Another option is an autocallable on the FTSE. These products automatically mature if the market reaches a pre-agreed level. It’s also worth considering accelerated trackers, which are available from Societe Generale and RBS. These products have expiry dates a few years in the future and you gain if the index reaches a pre-determined level on the date of expiry. Crucially, though, you don’t have to hold the product for its entire lifetime. You can sell it back to your issuer and still make a profit since the value of the accelerated tracker rises with the FTSE 100.
For investors who think the UK is on the right track then a long FTSE position could pay off later this year.