He says while a strong pound, an unusually cold US winter and amplified geo-political tensions over the Ukraine/Russia stand-off have dampened markets, the prospect for strong growth in global equity markets is improving.“Although the chances of a low double-digit capital return have diminished slightly, there are as many reasons to be more optimistic about equity returns from here as there are to be pessimistic,” he said.
“The FTSE does not look very inspiring to the chartist. Just about scraping out higher-lows but not having made a higher high since May. Understanding that we will need some fireworks in the final third of the year, the question is should we reduce our forecast?”
“We’re not going to. The chances of hitting the target have dropped, but not materially. There are a number of mitigating features of the UK which partially explain how lacklustre it has been.”
According to FE Analytics, the FTSE 100 has gained 3.66 per cent since start of year and is currently trading at 6,813.
Having reached a 14-year high of 6877 in May the market has oscillated above 6800 for most of the past three months.
It has outperformed the TOPIX and MSCI Europe ex UK the beginning of 2014 but has gained less than half of the S&P 500.
The S&P 500 rose 8.94 per cent, the TOPIX 0.69 per cent and the MSCI Europe ex UK has 0.5 per cent risen over the same period.
Performance of index in 2014
Source: FE Analytics
Foster believes the primary reason for ongoing strength in equity markets is the lack of options elsewhere to allocate assets.
“The most meaningful change to valuation has occurred through a fall in the discount rate or opportunity cost of equity ownership.”
“Throughout the developed world we were expecting a cyclical rise in bond yields as investors continue to price in a reflation cycle. Instead we have seen them trade sideways and more recently lower.”
The value of the market for both UK and global high yield has continued to rise, pushing yields lower over the course of the year, leading several managers to warn over a liquidity crisis in bonds in general but particularly in the high yield part of the market.
Performance of indices over 3yrs
Source: FE Analytics
Foster said: “With extra monetary stimulus appearing increasingly likely in the eurozone and a dovish tone from other developed market central bankers, the likelihood is that bond yields will remain below our original forecasts by the end of the year. On that basis our fair value estimate is well supported.”
He stands by his bullish forecast at the start of the year when he anticipated the FTSE 100 would reach 7400 points by the end of 2014, saying the index’s performance in the second half of the year will surpass its performance in the first half of the year.
“We made our forecast at the beginning of December when the index was at 6,600 and we called for it to rise to 7,400 by the end of 2014 (7,408 in fact). That would provide a return of 12.2 per cent in capital terms and 15.9 per cent after dividends (we estimated).”
“Right now we have about four months left to run and things are a little behind schedule.”
Foster says the strength of the pound versus the dollar partly explains about 1 percentage point of the underperformance of the UK and outperformance of the US but most of the rest comes from unexpected events and an overly sanguine outlook at the start of the year.
“Investors may have been too optimistic going into the [first] quarter. There were also some events which were difficult to forecast. One was the US polar vortex weather pattern which depressed economic activity in the first quarter. The second was heightened risk aversion driven by the crisis in Ukraine.”
“As the year has progressed there is clearly some economic impact of the crisis but the mutually harmful nature of sanctions between European and Russia make a breakthrough [in negotiations] very possible, if not probable.”
Despite his bullish outlook Foster admits to reducing some equity exposure in recent months due increased risk from geo-political crises but says the likelihood of the further escalation is not strong enough to knock back UK equity markets.
Foster is among a number of bullish managers predicting the FTSE 100 will reach an all-time high this year, including Old Mutual’s Richard Buxton, GLG’s Henry Dixon, Investec’s Max King and Psigma’s Tom Becket.
Buxton in particular is more bullish than most UK equity managers.
He is predicting a 10-15 year bull market for UK equities, as he said in an interview with FE Trustnet in March this year.
