What lurks beneath

7 Apr 2015

The FTSE 100 finally broke through the elusive 7,000 barrier last month, hitting 7,018.24 on 20 March. The last time the market was even near such lofty levels was during the dotcom boom in 1999.

However, although other major global indices hit their records much sooner, investors have been rewarded by healthy dividend payments.  The big question going forward is how much farther can the market climb?

At the big picture level, UK equities look appealing. The economy is less bubbly than in 1999, when interest rates were 5.5% and annual growth was around 3%. Today, rates are at rock bottom levels, the UK growth is storming ahead of continental Europe and the current level of the FTSE is underpinned by company profits to a much greater extent than it was before the millennium.

In addition, the main index is 50% cheaper, judging by price-to-earnings   ratios, than it was in 1999 while dividend  yields are running at a 100-year high to 10-year gilts.

Asset manager Research Affiliates predicts  that the UK market is primed for a 5.7% annual return over the next decade which offers significant value compared to the US which is expected to churn out a mere 0.7% as well as other low performing markets of Germany, France and Japan.

Not surprisingly,   the UK is likely to lag behind the cheaper markets of the European periphery,   such as Italy and Spain. Numbers crunched by academics also show   there is more steam left. Professors Elroy Dimson, Paul Marsh and Mike Staunton of the London Business School, which produces a definitive annual study of global stock returns for Credit Suisse, found that UK equities delivered a real return of 5.3% since 1900. Using their base case assumption that the market can get back to a 6% nominal return over the long term, there is a 50/50 chance the FTSE can soar to 10,000   by the end of 2022.

POLITICAL UNCERTAINTY

While this sounds good on paper, there are   no guarantees and caution remains the   watchword for now. One reason is the   upcoming   election in May.   As Danny Vassiliades, principal at Punter Southall, puts it: “The market doesn’t like uncertainty and it is difficult to see any party winning a majority. However, if a coalition is set up swiftly and a policy is set in place with a clear message, that would make investors more comfortable.

“The   worst outcome is a minority government   that limps along because that scope of uncertainty   would not be good for markets.”

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