Join our community of smart investors
OPINION

What record high?

What record high?
March 24, 2015
What record high?

First, what matters for investors are total returns - price changes plus dividends. Because, over the long-run, dividends account for most of the returns on equities, the FTSE 100's total return index is more important. It surpassed its December 1999 level way back in February 2006. And it is now 70.5 per cent above that peak.

Secondly, the FTSE 100 is a nominal index. Comparing its level now to its level years ago therefore obscures the fact that inflation has eroded its value. If we adjust for the consumer price index, the FTSE 100's price index is even now 26.1 per cent lower than it was in December 1999. This means a unit of the FTSE 100 buys you 26.1 per cent fewer goods and services than it did back then.

To put this another way, the FTSE 100 would have to be over 9500 for it to exceed its December 1999 peak in real terms.

If we look at the total return index adjusted for the CPI - a far truer measure of investors' returns than a nominal price index - things look better. It is 23.6 per cent higher that it was in December 1999.

Thirdly, talk of the FTSE 100 being at a record high poses, but does not answer, an important question: why should this be noteworthy?

Put it this way. The latest national accounts show that profits hit an all-time high in the third quarter of last year. Nobody mentioned that. And nor should they have, because such records are common: that was the fourth quarter since 2011 in which profits hit a record. Shares are a claim upon profits. So why should "shares at record highs" be news when "profits at record high" is not?

The answer, of course, is that, as Robert Shiller famously demonstrated in 1981, shares are significantly more volatile than profits, and even more so than the discounted future value of them. If shares were as stable as Shiller thought they should be, they'd hit record highs so often that we'd not see fit to remark upon the event. "FTSE 100 at record high" is only a headline because shares are more volatile than the real economy.

Economists disagree upon why this is the case. It could be because of herding and irrational sentiment. Or it could be because investors attach varying probabilities to scenarios which, while reasonable, do not actually materialise: in 1999 they thought there was a chance of immense prosperity and in 2009 the chance of catastrophe.

Whatever the reason, the fact that the FTSE 100 price index is even now far below its peak in real terms reminds us that, once bubbles burst, it can take decades for prices to return to their previous peaks. Equally, though, the fact that the real total return index is well above that peak reminds us how important dividends are.