The Year Ahead: Strategists predict a rocky ride in 2010

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The Independent Online

The FTSE 100 is expected to remain on the recovery path next year, with market-watchers anticipating a rise of more than 10 per cent as the world economy regains its composure over the next 12 months. But progress will not be smooth.

The blue-chip index is forecast to rise to 5,800 by the end of 2010, according to a Reuters poll of around 20 strategists, with estimates ranging from 3,300 to 6,640. The forecast compares favourably to 2008, when, battered by the financial crisis, the benchmark slumped by 31 per cent. But it still represents a slowdown on the current year when, barring a sharp reversal in fortune over the next week, the index is on track to register a rise of around 19 per cent.

Of the professionals polled by The Independent last year, only two came close to predicting the extent of this year's rally. David Keir of the Scottish Widows Investment Partnership accurately foresaw the rise beyond the 5,000-point mark, although his year-end forecast of 5,100 is still likely to fall short. Aberdeen Asset Management's Charles Luke is also likely to be proved just a touch bearish, but he was in the right ballpark with a year-end estimate of 5,000. Others were far too pessimistic about 2009.

As for next year, Morgan Stanley is decidedly cautious. Despite forecasting a 34 per cent hike in earnings over the next 12 months, the broker expects the FTSE 100 to fall back next year. "Policy stimulus should remain supportive overall and profit growth should be very good, however this is countered by valuations that are not overly attractive in absolute terms and nervousness about the durability of economic growth as and when policy support is withdrawn," Morgan Stanley says, forecasting a retreat to 5,000 by the end of 2010.

Such is the base case. Morgan Stanley's bear forecast foresees the market sliding to 3,600. "A bear case outcome for stocks would follow one of two scenarios – either the economic recovery runs out of steam of its own accord and growth takes a renewed lurch down, or inflation fears force central banks to hike [interest] rates more aggressively than they would like and short circuit the recovery," the broker says, attaching a 30 per cent probability to the market lurching so low.

JP Morgan is far more optimistic, and anticipates a rally to 6,150. "One of the big push backs to the bullish view is that the current economic stabilisation is seen as 'artificial' and unsustainable," the broker says. "However, the key condition investors wanted to see in order to turn more constructive is the credit market normalising – this is happening."

Nomura is also bullish, and in contrast to its cautious stance on continental Europe, expects the FTSE 100 to rise to 6,000. The broker says its optimism is based on the view that, like sterling, the UK market had suffered disproportionately as a result of the financial crisis. "We think this leaves an opportunity for investors to buy relatively cheap assets in a relatively cheap currency," Nomura says. "There are risks, perhaps one of the main ones being the upcoming election. A likely change of government should mean a tightening of the fiscal stance but, on the other hand, the Bank of England is likely [to] maintain an extremely loose policy until after the effects of the fiscal tightening have been assimilated."

Credit Suisse has pitched its tent in the middle of the road, and expects the benchmark, which closed just north of the 5,200 point market on Friday, to be broadly unchanged at 5,300 at the end of next year. The strategists at Standard & Poor's Equity Research, who forecast a rise to 5,674, are slightly more optimistic about the Footsie's prospects. They do expect the UK market to lag behind its European peers, however.

"Equities are our preferred asset class and are in our view more attractive than credit, cash or real estate," S&P strategist Robert Quinn says in his outlook for 2010. "For 2009, equities have been the biggest absolute gainers; but, on a risk return basis, corporate credits have been winners."

Whatever the level at the end of the year, 2010 is likely to prove a rockier ride for the FTSE 100. Save for the slump in the first three months of the year, the index has enjoyed a prolonged rally in 2009.

Concerns about a reversal in fiscal and monetary policy, coupled with the uncertainty surrounding the general election, are likely to weight on sentiment.

"Volatility is bound to increase over the next six to nine months, particularly when compared with the relatively straight run seen since March," Richard Buxton, head of UK equities at Schroders, said in a recent note on the year ahead. "Encouragingly, however, valuations on UK equities are completely supportive and in no way stretched, which should limit the downside during periods of volatility."