There is nothing like a bit of October to put the wind up investors. Thanks to the great stock market crashes of 1929 and 1987, both of which happened in the tenth month, October has a poor reputation among shareholders. That credit crunched last autumn, too, only blackens the name of the season.

This year the sense of foreboding is all the more disconcerting because the markets had such a thoroughly heartwarming third quarter of the year. What goes up, the bears fear, must come down.

Yes, we all know that financial markets, especially equity markets, tend to anticipate events, and will react positively well before an actual improvement in the economic climate. But economic recovery is far from secure. We also know that markets have predicted five of the past two recessions and they are perfectly capable of calling the economic recovery, whenever it comes, at least three or four times before they get it right.

So will the markets turn turtle? The risk is tangible, though not overwhelming. The threat is greater if the FTSE 100 index is the benchmark by which you judge these things. For technical reasons touched on in this column several times in recent months, anyone who thinks that the FTSE is truly representative of UK plc should surely think again.

To recap: the FTSE 100 comprises the largest UK quoted companies, and movements in the index are weighted so that changes in the shares prices of bigger companies exert greater influence on the overall direction of travel.

The ten largest FTSE 100 companies — HSBC, the bank, down to BHP Billiton, the mining company — account for nearly half the value of the index, which means that they dictate half the daily movements in the index. At the same time, banks and other financial services companies make up 25 per cent of the value of the index, with mining and oil companies driving a massive 30 per cent of index movements.

The FTSE 100, therefore, will catch a dose of the October collywobbles if trouble strikes one or both of these relatively narrow realms of business. Investors might well lose faith in the recovery prospects of the financial services and natural resources sectors. Just as worryingly, shares in these sectors have been among those to have risen most quickly in the past few months and the prices are high enough to look vulnerable. Mining companies, for instance, give half the dividend yield of FTSE 100 peers. Meanwhile, markets being what they are, bad news from the financials and/or oil and mining sectors could prompt a marketwide wave of selling.

The evidence is not uniformly worrying, however. Intelligent investors should also look beyond the oddly actuarial rules that determine the constitution of the FTSE 100 to arrive at a more nuanced, and potentially profitable, response to the dangers.

The proper question to ask is not “will the FTSE 100 crash?” but “which stocks in the FTSE 100, or elsewhere, look overvalued?” Lonmin, the platinum miner, trades on a price-to-earnings (p/e) ratio of 120, according to the Datastream number-crunching machine. Tullow Oil, Randgold, Fresnillo and Kazakhmys also sit at the top of this chart. HSBC is trading on a p/e ratio of 20, and that makes shares in the big bank look decidedly expensive.

The convulsions of recent months mean that statistical data such as this needs to be treated carefully because special circumstances can render it anomalous. That said, shares in HSBC and Barclays are supported by pretty paltry dividend yields.

That the data suggests that some of these shares might fall in value does not mean that the underlying companies are necessarily bad, of course. Nor should it prevent investors from building good positions in those whose long-term prospects are sound. Indeed, sensible investors may decide to ignore all this talk of an upcoming crash, secure in the knowledge that the best long-term investment tactic is to drip-feed money in and out of shares, and that attempts to time perfectly investment entries and exits is laden with more danger than opportunity.

It is also only appropriate to point out that overall the FTSE 100 looks fairly valued, or even a touch on the cheap side. It trades on a historic p/e ratio of 16, in line or just below the ten and fifteen-year averages, as the chart above shows. The historic dividend yield of 3.4 per cent is also in line with what is typical over the longer term. Averages being what they are, however, if some shares are overvalued, others will be cheap. And while all stocks may be tarred with the black brush of a temporary reversal, it is the reasonably-priced shares that are least likely to suffer long-term damage.

This week’s eyecatchers include Scottish and Southern Energy, the power supplier, whose shares sit on a p/e ratio of 10 and give a dividend yield of 6.5 per cent. Also AstraZeneca and GlaxoSmithKline, the large-cap drugs businesses, RSA Insurance, the general insurer that has grown out of the ashes of Royal & SunAlliance. That old favourite of mine Vodafone, along with the oil groups BP and Royal Dutch Shell, which are giving dividend yields of more than 6 per cent, also look cheap despite some of their sector peers seeming quite the opposite.

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