What can the very long term tell us about the trend of the UK market?
[This is an update of an article that first appeared in April 2013.]
The chart below plots the FTSE All Share Index from 1946 to the present day.
- The Y-scale is logarithmic, which presents percentage (rather than absolute) changes better over long periods, and so is more suitable for long-term charts.
- The straight line is a line of best fit calculated by regression analysis.
- The R2 for the line of best fit is 0.96, which is impressively high for such a simple model (i.e. the line of best fit fairly accurately approximates the real data points).
- The FTSE All Share Index fluctuated closely around the trend line (line of best fit) from 1946 to 1973; it then traded consistently below the trend line until 1983, when it crossed over to trade above the trend line until 2001. From 2001 the Index was close to the trend, but then in 2008 fell significantly below it and has yet to revert to the long-term trend line.
The equation of the line of best fit in the chart above (with a little more precision) is-
y = 0. 846531e0.000207x
This equation allows us to make forecasts for the FTSE All Share Index. It is, in effect, the Holy Grail, the key to the stock market – as simple as that!
For example, at the time of writing the FTSE All Share Index is 3664 while the above equation forecasts a value today (according to the long-term trend line) of 5878. This suggests the index is currently under-priced relative to the long-term trend line. But as can be seen in the above chart the index can spend long periods trading above or below the long-term trend line.
Now, if we think that the trend of the market in the last 70 years will broadly continue, then we can use the equation to forecast the level of the FTSE All Share Index in the future. And this is what has been done in the following table. Equivalent forecasts for the FTSE 100 Index have also been given.
||FTSE 100 Forecast
The equation says that the trend line value for FTSE 100 at the end 2017 will be 11,762 (75% above its level in November 2016,).
By end 2020 the forecast is for a FTSE 100 level of 14,761 (+119%), and by end 2040 the equation forecasts a FTSE 100 trend value of 67,068 (+897%).
So, that’s easy.
Well, except this…
We will now look at a trend line calculated from data 1920 to 2016.
First, here is the chart from 1920 with its trend line.
In this case, the R2 is 0.69, quite a bit lower than than the data from 1946 (i.e. the calculated trend line is not such such a good fit for the actual data).
Again we can use the equation of the trend line to forecast trend values for future dates.
||FTSE 100 Forecast
Whereas for the data from 1946 forecast a FTSE 100 level of 11,762 at end of 2017, the 1920 data forecasts a level of 7,652 (14% above the current level).
As can be seen above, the trend-line equation is very sensitive to the sample data (i.e. in this case, the choice of start date).
So, which trend do you prefer, that from 1920 or from 1946?
The above is partly an extract from the new 2017 edition of The Harriman Stock Market Almanac.
Order your copy now!