Anyone who follows the stock market and market commentary will know that many major banks and institutions currently favour the FTSE 100 noting attractive stock valuations versus the US and a stronger macroeconomic environment than Europe.
However, the UK index still suffers from poor sentiment, a lack of momentum, and a lack of tangible growth catalysts. So, let’s take a look at mistakes to avoid when investing in the index.
Avoid negative momentum
Some of the best quantitive models for investing put considerable emphasis on share price momentum. If a stock is going up and the valuation and growth metrics are favourable, it will likely continue to go up.
A closer look at the FTSE 100 reveals that many stocks are simply treading water or falling despite favourable valuations. As such, investors should be wary that their investments might stagnate or lose money even if the headline metrics appear attractive.
Companies like Phoenix Group, Legal & General, and Diageo — all of which have been part of my portfolio over the last decade — have simply underperformed despite attractive valuations.
Moreover, I’ve learned not to try and catch falling knives. And every now and then I need to be reminded of that. Earlier this year I made a very small investment in Burberry — it ended poorly.
Stocks need Catalysts
In this type of market, stocks need catalysts. Catalysts can come from anywhere. It could be consecutive earnings beats or it could be an election or planned tax cuts. As it happens, I don’t see a host of catalysts for the FTSE 100 as a whole, but more focused research may unveil stronger investment theses.
While artificial intelligence (AI) hasn’t had a major impact on the index (especially compared with the US), some stocks like Sage Group are reaping the benefits. Congratulations to my colleague Edward Sheldon for picking the stock before its recent rally.
Conversely, a lack of catalysts can simply mean a stock will continue to tread water for the foreseeable.
Concentration risk
Around 70% of FTSE 100 companies’ sales originate outside the UK. But that doesn’t mean the index won’t slump if economic or political events in the UK start to look unfavourable. This leads me to concentration risk. It’s important to spread investments across different sectors and different geographies. While the US stock market might look expensive, we can still find excellent investment opportunities.
My FTSE 100 pick
My favourite stocks on the index right now are Scottish Mortgage Investment Trust (LSE:SMT) and International Consolidated Airlines Group. Both have strong momentum which is supported by attractive valuation multiples.
The former invests heavily in US-listed tech stocks and offers the best exposure to AI and new technologies on the FTSE 100. That’s because the trust invests in companies like Nvidia, Tesla, and even unlisted pioneers like SpaceX.
What’s more, it currently trades at a 10% discount to its net asset value, suggesting that I’m buying Nvidia exposure at a 10% discount.
However, this tech space can be volatile, especially when we see Tesla trading at 100 times forward earnings. Moreover, investors may also be cautious of private sector valuations — which account for around 25% of the fund.
Nonetheless, I can’t get such exposure elsewhere on the index. And the stock pickers have a great record. It’s worth considering, I feel.
This post was originally published on Motley Fool
