Could 2014 be the best year for UK equities since 2009, when the FTSE 100 (UKX) index posted a gain of a little over 22%?
Analysts at Citigroup think so: they expect the blue-chip index to hit 7500 by the middle of 2014, and to break through the 8000 barrier by the year end.
That would represent a return of getting on for 20% from UK equities, depending on the end of 2013 close.
Other equity analysts are also bullish about the prospects for 2014 – though none are quite so optimistic as Citigroup. For example, Goldman Sachs’ forecast is for the FTSE 100 to reach 7500 by the end of the year.
A poll of 400 analysts by Reuters a few months back found that 36% expected the market in 2014 to exceed the all-time highs not seen since the final days of the 1990s, hitting values of between 7000 and 7500 during 2014.
To find out how to best take advantage of the recovering economy, read: Three routes into UK equities in 2014.
There are dissenting voices that point to difficulties ahead – not least the 7% of analysts in the Reuters poll who predicted a 2014 FTSE 100 year-ending value below 6000 – but many stockmarket pundits are feeling more positive about the outlook for UK equities than at any time since the financial crisis.
“The focus should be increasingly on companies with exposure to growing markets, be they cyclical, defensive or financial, and irrespective of country, sector and size,” argues Andy Brunner, an investment strategist with Morningstar.
“Additionally, yield will remain important in a low interest-rate world and some higher- yielding stocks, albeit only those with rising dividends, remain favoured.”
We believe the implication of ‘Yellenomics’ is that monetary policy will be very supportive of economic expansion for the next several years.”
The bulls cite three reasons to be excited about next year. The first is the macroeconomic outlook, with the UK now recovering more quickly from recession and slowdown than had previously been expected.
The Bank of England’s upwards revision of its growth forecasts in November – it now thinks UK GDP growth in 2014 will be 2.8%, rather than the 2.5% it forecast in August – underlines that change of sentiment.
Nor is it only the UK where recovery now looks more entrenched. In the eurozone, a break-up of the euro, with all the turmoil that would cause, now seems far less likely than it did even a year ago.
The single currency crisis seems finally to be receding. In the US too economic momentum is building.
The second positive factor is the outlook at the corporate level, with earnings from UK companies continuing to improve, to the extent that many companies are now finally beginning to revisit thoughts about merger and acquisition activity (and UK companies may also be targets for international M&A).
Citigroup describes company boardrooms as currently inhabited by “animal spirits”.
Rising earnings have also helped to underpin valuations. On the basis of earnings over the past 10 years, the UK stockmarket currently trades on a cyclically adjusted price/earnings ratio of around 15, which will reassure many investors – that’s about half the level seen in 1999 just before the dotcom crash.
The third argument for a strong stockmarket in 2014 is improving appetite for risk – with the recovery now secured, investors in UK equities are back in “glass half-full” mode.
That’s all the more pronounced, given the difficulty of securing positive real rates of return from other asset classes while interest rates remain so low.
The rising appetite for risk is clear from data showing that funds are now flowing back into equities from both retail and institutional investors, though not on the scale sometimes predicted by proponents of the theory that a “great rotation” from bonds into equities is due. (This “reduced rotation” may reflect the need of investors such as pension funds to continue buying bonds as the best match for their liabilities.)
So what might derail the stockmarket gravy train next year? The biggest risks are external.
Most obviously, the US Federal Reserve has promised, in time, to rein in its quantitative easing (QE) stimulus programme – and each hint this year that the Fed was about to ease back on bond purchases sent global markets tumbling.
To find out how market commentators and experts have reacted to the Fed’s decision to taper, read: Market reaction to US Fed’s taper decision.
Indeed, the UK stockmarket has been broadly flat since the summer months when Ben Bernanke, chairman of the Fed, first began suggesting that tapering of QE was on the cards.
The good news, says Richard Hoey, chief economist at BNY Mellon, is that Bernanke’s replacement with Janet Yellen next year is likely to delay the start of tapering.
“We believe the implication of ‘Yellenomics’ is that monetary policy will be very supportive of economic expansion for the next several years,” he argues.
Nevertheless, if the US economy continues to improve, an end to economic stimulus – first a tapering of QE and then, eventually, a rise in interest rates – will move up the agenda. That is likely to spook many investors, just as it has in 2013.
Another big risk for UK equities, and developed market equities in general, is an unexpectedly severe slowdown in emerging markets.
In the short term, tapering may increase volatility, but it is amazing how resilient the UK market is. Equities can still rise alongside gently rising yields.”
There is no doubt that a slowdown is underway, and not just in China, where the authorities have deliberately put the brakes on growth over the past couple of years.
Western companies are reporting slowing sales across Asia and Latin America; mounting debt levels in many countries have been causing concern; and there is also fear that the monetary stimulus from the west, particularly the US, has masked deep-rooted structural problems in many economies that governments haven’t been willing or able to tackle.
Once that stimulus is withdrawn, these problems may be exposed.
A severe shock in the emerging market universe would be disastrous – many western banks remain weak, certainly too weak to cope with debt defaults from their emerging market customers, whether corporate or sovereign.
And with public debt levels in western economies also still at stratospheric levels, there is no cushion to cope with such an eventuality.
To find out what countries are challenging the BRIC group, read: Four countries tipped to make you a MINT.
These concerns are giving some experts pause for thought, even if they’re broadly positive.
“If the UK economy is really on the road to recovery, this will be positive for the stockmarket, but it is important to recognise that overseas sales make up about 70% of the revenue of FTSE 100 companies and so what is happening elsewhere in the world is also hugely important,’ warns Patrick Connolly, a certified financial planner at independent financial adviser Chase de Vere.
“While we are positive about the outlook for UK equities, it should be remembered that the market has made strong gains over the past 18 months with relatively modest earnings growth, and so could be due a correction in the short to medium term,” he warns.
However, Richard Buxton, head of UK equities at Old Mutual Global Investors, is less nervous.
Buxton, who joined Old Mutual earlier this year after a long and successful career at Schroders, is predicting a year-end FTSE 100 finish of 7000 to 7300 in 2014, even if there are some hiccups along the way.
“I have already said I think we are through the worst and I stand by that – we are in for a much better period in the UK,” he says.
“In the short term, tapering may increase volatility, but it is amazing how resilient the UK market is. Equities can still rise alongside gently rising yields.”
Investors with UK equity exposure will hope he is proved right.