The falling FTSE: How worried should we be?

By Brian Milligan
Personal Finance reporter

Published
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The index of the UK's biggest 100 companies, the FTSE 100, has now fallen by 15% since its all-time high on 27 April 2015.

That makes it more serious than a technical correction, normally thought of as a fall of 10%. However, it is not yet a bear market, which is the term used when the index drops 20% or more.

The index of the next biggest companies - the FTSE 250 - is down by 10% since its peak on 3 June.

While the current rout of prices was initially confined to commodity and mining stocks, hit by the slowdown in China, the slump now looks much more widespread.

"We are in the midst of a full-blown growth scare, with China at the epicentre," said a note from analysts at JP Morgan.

So how worried should we be by such events - or is there even a silver lining to this crisis?

How big is the fall?

Monday's fall on the FTSE 100, of 4.67%, is not that big in historical terms.

On 19 October 1987, otherwise known as Black Monday, the index fell by 10.84%. The following day, it fell by a further 12.22%.

On 28 October 1929, at the start of the Wall Street crash, the Dow Jones Industrial Average fell by 12% - and a further 11% the day after.

What is more significant, however, is not the individual one-day falls, but the longer-term declines.

In 1987, for example, Black Monday was followed by a true bear market. By the end of the month, the FTSE 100 had fallen by more than 26%.

During the financial crisis of 2007-08, the FTSE 100 peaked at 6,724 on 12 October 2007, reaching a trough of 3,512 on 3 March 2009 - in all, a drop of 47%.

Interest rates

One immediate impact of the current market turbulence is likely to be a further delay in an interest rate rise.

The Bank of England's Monetary Policy Committee (MPC) primarily looks at inflation expectations when considering any change in rates - and those expectations are still being driven by China.

China's recent devaluation has only increased its capacity to export deflation, so corralling inflation in western economies.

So despite recent suggestions by the governor of the Bank of England that a rise might be expected as soon as the end of 2015, analysts now expect that rise to come considerably later.

In other words, those on variable-rate mortgages can now breathe more easily, and may not have to hurry to switch to a fixed-rate deal.

"I think it's good news for mortgage holders, as it must put back the date of the next rate rise," said mortgage expert Ray Boulger of brokers John Charcol.

On the other hand, the news will inevitably not be so good for savers, who will have to stomach record low savings rates for a while longer.

Investors

How much you should worry about the stock market fall probably depends on your age.

Those in their 50s, approaching retirement, will have much more to be concerned about than younger people. In particular, anyone about to take out a pension, or indeed thinking of cashing in their pension, may have to think again. (See pensions below).

But younger people with pensions, or those investing in the stock market directly, may have little to fear.

Admittedly, some analysts worry that the markets have further to fall.

"Against this backdrop, it would take an investor with nerves of steel to contemplate dipping back into the market at this point," said Michael Hewson, analyst at CMC Markets.

But other experts say that young investors will have plenty of time to make their money back - and indeed could make a lot of money by investing now.

"For younger investors, falls like this are great," says Mark Dampier, investment analyst at Hargreaves Lansdown.

"You're buying the market way cheaper. You should be adding."

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Pensions

But you don't need to hold shares directly to be hit by the current slump.

If you are paying into a pension, the chances are that about 70% of it is invested in shares or share-based funds.

While you will now be feeling considerably poorer, it only really matters if you are about to cash in your pension, buy an annuity or set up a drawdown policy.

In that case, your capital will have shrunk, and now may not be the best time to buy a pension.

Mark Dampier is particularly concerned about those who already have a drawdown scheme in place.

Pensioners in drawdown leave their capital invested and "draw down" an income from it. But falling share prices can erode the capital quickly.

"If you are in a drawdown plan, this is definitely the time to check you are not drawing down too much from your capital," he told the BBC.

Those who do are in danger of running out of money before they die.

'Scary'

On the other hand, many pension pots will not have fallen in value by as much as the FTSE 100.

Smaller companies - particularly those not in mining or commodities - have fared better.

And while many funds typically invest 70% in shares, 30% is often invested in bonds - which may even have gone up in value over the last few months.

Those whose pensions are in so-called lifestyle funds will anyway have seen some of their capital gradually transferred into bonds, as they get nearer retirement age.

The outstanding question, as ever, is whether the slump has further to go, and how long it may take markets to recover.

"This is a nasty correction," said Mark Dampier. "And nobody knows whether there's more to come. That's what makes it scary. But unless this is the death of capitalism, stock markets do recover."