A Look Forward into 2015

Monday, 12th January 2015 14:33 - by David Harbage

After making strong progress in calendar years 2012 and 2013, the UK equity market ignored consensus forecasts to consolidate in 2014 - by reference to the FTSE100, FTSE250 and FTSE All Share indices.

But beneath the headline flat annual performance, there was a marked pickup in volatility in the final quarter of 2014 (the FTSE100 see-sawed between 6,200 and 6,700) and smaller company AIM listed stocks fell by more than 20%. 

The old saying of investors preferring to 'travel' rather than 'arrive' was borne out as the stock market seemed to take scant notice of positive domestic economic news: 2014 is likely to have delivered above trend growth (GDP of 2.6%, up from 1.7% in 2013), benign inflation (CPI of 1.5%, versus the previous year's 2.6%), a fall in unemployment (to 6.4% of the total workforce, from 7.6%) and healthier public finances (5% of GDP, as compared to 2013's 5.6%). 

Clearly also reflecting that most of the FTSE100's constituents are typically global businesses, and that investors are as perturbed by uncertainty as bad news, per se, the market wrestled with a number of issues in 2014 which appear set to dominate sentiment into the first half of the new year. In particular, but not necessarily in order of importance:

• Geo-political concerns surrounding Russia's involvement in Ukraine, the emergence of ISIS in the Middle East (notably Syria and Iraq) and a threat of cyber attack on government, corporations or individuals.
• Weak economic activity in the Eurozone and slowing growth in China, which central bankers are addressing via fiscal and monetary policy - leading to greater indebtedness and instability in their respective financial infrastructure.
• The dramatic fall in the price of oil in the latter part of 2014 and little evidence of wage growth is depressing inflation - a medium term positive, upon the cost of living and doing business, but a drag on government and consumers' ability to reduce debt.
• While the world's largest economy (the United States), and that of the UK have performed well, the prospect of slowdown elsewhere - including emerging economies that may have to raise interest rates to counter depreciating currencies - cannot be ignored.
• At a time when top line revenue growth may become more difficult to achieve, corporate accounting scandal and management behaviour has been called into question (across a range of industries, and certainly not confined to banks).
• Domestically, the rapidly changing political landscape - featuring the growing popularity of the smaller parties - could lead to a 'hung' parliament come May 2015; a coalition, with the likes of the SNP or UKIP sharing power within a coalition, increases uncertainty (surrounding strategy for public debt reduction or trade with Europe), which could lead to a weaker £ and increase the prospect of higher interest rates, sooner.

• Global economic growth (and local inflation, interest rates and currencies), to decouple, with US (GDP to be 3.4% in 2015) and the UK (2.5%) strong, but continental Europe and ex-Asian emerging economies weakening.
• No political party to have a clear majority after the UK general election, producing something of a vacuum in domestic policy. Interest rates to rise in the final quarter of 2015 in response to an anticipation of a pickup in inflationary pressures (the oil price to recover towards US$80 per barrel) in 2016. Benign inflation (CPI of 1.3%) and public finances (deficit 4%) in 2015.
• The overall UK equity market to break into new territory, but unlikely to make dramatic progress, with the FTSE100 index set to end the year at 7,100. After allowing for 3.5% in dividend income, this equates to a total return of 10%.
• Higher yielding, blue chip quality (perceived to be dominant or a leader in its industry, by reference to track record and current position, with strong tangible and valuable intangible assets, a lowly geared balanced sheet, well regarded stakeholder management) investment to outperform the wider market, as greater focus on 'bottom up' stock selection applies.
• Oversold neglected segments of industry to recover, notably the equity worth of fully integrated oil & gas businesses and banks (in anticipation of higher interest rates). Certain cyclical sectors such as technology and, on a more circumspect basis, industrials appear to undervalue the pace of change in secular behaviour.
• Helped by recent changes in stamp duty and the prospect of longer term rates remaining low in 2015, UK house builders to enjoy a 'stronger for longer' cycle. Net demand for gold increases driven by country-specific concerns surrounding recession, inflation or currency worth.
• A pickup in Merger & Acquisition activity, to supplement businesses' earnings from core trading

Finally, the one thing we can be sure of is surprise - let us hope they are, on balance, positive.