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Economic Growth and the FTSE 100

Alfie the Cocker Spaniel

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Writing in Businessweek in March 2013, Peter Coy quoted Roger Farmer – Distinguished Professor of Economics at UCLA and Senior Houblon Norman Fellow at the Bank of England – as likening the stock market and the economy to

" two staggering drunks connected by a long rope "

A better comparison could be made between -

The Cocker Spaniel and the Economy

gdp_ftse

The chart here shows the progress of both the economy, as represented by GDP, and the stock market as represented by the FTSE 100. Just as a dog owner on a walk will make steady, purposeful progress throughout their journey, checked only by the odd obstacle, so the economy tends to grow at a relatively steady rate, with progress checked only by obstacles such as the recession of 2008. The stock market, like the spaniel, will experience a very different journey over the same time period; the latter is likely to race into the distance, leaving their owner behind while pursuing some new and exciting scent (perhaps of rabbit or squirrel) before obsessing over a new-found stick and ultimately falling behind until called back to heel. Investors, like the spaniel with its scents and sticks, will chase some illusory market bubble only to be brought sharply into line by the inevitable crash. Despite these different journeys, very strong bonds link the relationships. The spaniel is cautious not to lose sight of his owner – even if he returns only on the promise of a tasty treat. Investors are likewise brought back to reality, not by the allure of a tasty bone, but instead through the realisation that the companies whose share prices make up the index, are the ones that create the economic growth. In the long term the market and the economy, spaniel and owner cannot drift too far apart.

The FundView Market Index

The FundView Market Index is a very simple measure of how far apart the FTSE 100 is from the economy that underpins it. This index is of no value in predicting where the market might be heading, so why create it in the first place?

There are two principal reasons for creating such an index:

  • By comparing the index at the start and end of an investment period with the returns produced by a particular investment fund we get a clearer picture of how the fund has performed – the returns are not exaggerated by a general market rise or fall. You can see these underlying returns for UK-based funds in our Fund Ratings.
  • As a caution to investors: the biggest threat to an investment is not the possiblity of a market crash since these dips have been relatively short-lived. It is instead following the herd in chasing the bubble that represents the greatest risk for investors – ask anyone who invested their money in 1999 or 2007!

There is, however, no guarantee that the relationship between the FTSE and GDP will continue... just as it is impossible to predict what might happen if Alfie the cocker meets a black swan on one of his walks!