Asked on a TV programme last week where I think the market will finish at the end of the year, I found myself trotting out the safe but predictable reply that it will be higher but not by much. I then spent the rest of the interview worrying how to justify such a remark. I convinced myself more easily than I would have thought possible that such a scenario is likely. It will do no harm to rehearse the arguments again.
It is said that stockmarkets are driven by fear and greed. Certainly, in the shorter term, I would not argue with that but there are other more quantifiable drivers which must be taken into account. The amount of money available to invest is one, as is the supply of shares available. The price that people are prepared to pay also governs the direction of markets.
It is this latter measure that provides the best basis for believing that another positive year for shares is in prospect. If our forecasts are correct and a modest, if unexciting, rebound in corporate profitability and dividend payments takes place, then current valuation levels would support a market higher at the year end than when it started.
But current valuation levels are more subjective than you might think. What is cheap for ordinary shares? We presently stand at around 15 times 2004 earnings for the UK market but it has to be said that such a multiple is only cheap in the context of what shares rose to at the tail-end of the 1990s. There are signs that technology stocks have been returning to those exorbitant ratings last enjoyed just before they were tipped over the precipice. This is a more worrying development.
The climate has definitely improved but we have not returned to the remarkable conditions that existed at the end of the last millennium. IT spending was soaring. Today, it is the ending of the spending strike that is encouraging people to back technology once again. The encouraging aspect of all this is that it demonstrates that investors will pay for growth expectations. That suggests that one of the other criteria for stronger markets has been fulfilled.
The flow of investment money is harder to pin down. In the past, inflows to pension funds have proved an important source of cash. However, these have been directed increasingly towards bonds as pension funds endeavour to realign their portfolios to more closely address the liability issues that have arisen. Rising markets will help but I doubt that pension funds will ever trust equities as fully again.
Insurance companies have been forced sellers of equities as they endeavour to bolster their solvency ratios. The fact that buyers are out in force for certain sectors of the market suggests this trend may be coming to an end. Certainly, recent sales from this sector show the pain is diminishing.
As for the supply of shares, a factor towards the end of the bull market was the propensity of companies, most notably in the US, to buy back their own stock, reducing the availability of shares and driving prices higher. In the end, the stockmarket is like any other market. More buyers than sellers and shares rise. More sellers than buyers and they fall.
We are in danger of getting ahead of ourselves but most of the measures that might reasonably be used to judge where the market should be are looking positive. We should not underestimate the potential flies in the ointment, not the least being the Budget. But as the year progresses, I am feeling more comfortable with the market. Let us hope I am right.