Peering into a murky crystal ball for 2010
-Jeremy Batstone-Carr is director of private client research at Charles Stanley. The opinions expressed are his own.-
It‚Äôs that time of year again!¬† The time of year in which the writer‚Äôs desk, never a pretty sight at the best of times, becomes clogged with the product of the investment community‚Äôs crystal ball gazing.
Needless to say the vast majority is effusive in its enthusiasm for risk assets (turkeys don‚Äôt vote for Christmas) and makes an aggressive and fairly convincing case as to why equity markets will never go down again‚Ä¶ever!
However, for the Bob Cratchits of this world (well, our office Christmas party was cancelled) life just isn‚Äôt like that.¬† Most investors have learned the hard way that trees don‚Äôt grow up to the sky and share prices can go down as well as up.
According to consensus expectations, UK corporate profits are expected to increase by about 34 percent over 2010 and by 16 percent in 2011.¬† In part, this profit surge is down to many UK quoted companies‚Äô exposure to the still-fast growing Asian and, selectively, emerging market economies.¬† The earnings improvement is likely to be influenced by cost cutting and further working capital improvements.
While we suspect that we are at the bottom of the field in terms of our end-2010 forecast we are inclined to be more optimistic, selectively, on equities than we are on conventional gilt-edged.
We wonder if, despite apparent deflationary pressures, the long bull run in conventional government bonds, particularly (but not exclusively) in the UK, might be coming to an end.¬† The withdrawal of liquidity, coupled with policy tightening could contribute to a backing up in bond yields.
If benchmark medium-dated yields were to rise to about 4.75 percent or above we suspect that this too could act to hamper the equity market‚Äôs progress.¬† We might also add that the frisson created by Dubai World, although regarded as containable, should act as a reminder that risks associated with highly indebted nations remain elevated.
Concerns over Greece have also escalated and we hear rumours that Spain too might prove the epicentre of a sovereign debt crisis before too long.¬† These factors should serve to remind investors that seldom do returns come risk-free (although over 2009 the risk associated with equity investing proved to be about as low as it might ever be expected).
Factoring in a higher Equity Risk Premium to fair value calculations inevitably works to take yet more of the shine of the equity market outlook.
Given the level of conviction with which we hold our FTSE 100 end-2010 target of 4700 (50 percent) investors might be encouraged to hedge against the possibility that we could be wrong.¬† Having called the direction of equities right over both 2008 and 2009, 2010 represents a very different proposition.¬† Inevitably there are more optimists around than pessimists (the equity market is historically populated by optimists) and the bull case is predicated on a prolongation of ‚Äúsweet spot‚ÄĚ conditions for longer than we anticipate in our base case.
Assuming the UK equity market‚Äôs multiple expands yet further it would not be surprising to see the FTSE 100 push up to 6000 or even higher (25 percent).¬† You can bet, though, that it will be doing so against an ever steepening wall of worry.
We ascribe a similar probability to that outcome as we do a more deeply bearish scenario built around the possibility that the stimulus runs out (and is not augmented) and what revival in activity there has been gradually peters out.¬† Or, alternatively, that policy is tightened very aggressively (far from impossible in the UK context especially given the political requirement to get to grips with the country‚Äôs debt mountain), thus stopping the revival in activity in its tracks.
Under such circumstances (25 percent) it‚Äôs not inconceivable that the FTSE 100 might end 2010 below 4000 again.