We are now coming out of the Covid-19 pandemic and the arrival of the vaccine allows us to be more optimistic on the economic outlook as a consequence.
It is that time of year when stock market professionals are asked for their predictions on what the forthcoming year might return. However, there are good reasons why they are frequently reticent to put a number on where they think markets might rest in twelve months’ time. For a start, there seems little point in dividing outlook into calendar years. Why should the period between the 1st of January and the 31st December be any more important than from, say, the 1st of October and the 30th of September? Secondly, we tend to invest with a long-term time horizon. Stock markets are very variable, and returns can be unpredictable even over the medium term. It is very difficult to say with any certainty what returns might be over three to five years: it is little more than tossing a coin. We invest with a longer-term time horizon and this is something we always seek to convey to our clients.
But looking at our longer-term expectations, what do these tell us about the potential returns we might expect over the next twelve months? We are forecasting equity returns of between five per cent and eight per cent over the longer term with five per cent perhaps reflecting the US stock market and the UK market potentially offering something towards eight per cent.
We are now coming out of the Covid-19 pandemic and the arrival of the vaccine allows us to be more optimistic on the economic outlook as a consequence. Many people have not been able to spend as they would have wished throughout 2020 and as a vaccine is rolled out as we enter 2021, this pent up demand will stimulate the economy. Governments have been very active in providing finance and grants to keep economies functioning throughout this difficult phase and this should manifest itself in a relatively strong economic recovery. At the same time, this has been an unusual recession. Companies have been continuing to sell their goods and are not burdened with stockpiles of unsold inventory in their warehouses. As a consequence, as demand starts to return and feed through to the economy, businesses will begin to move back towards full capacity on their production lines. As a result, overtime and new hiring should pick up quite quickly leading to a relatively speedy recovery from the slowdown experienced during 2020.
So, where do we think stock market returns might be over the next 12 months? Our five per cent projection for US equities might be challenged given the elevated level of valuations in the US stock market. In contrast, the UK stock market is much cheaper by most valuation metrics and we could therefore potentially see returns in the high single digits, which is above our longer-term projections. However, this is subject to what happens with Brexit. Brexit will either be a relatively smooth transfer if the UK secures a clean and easy divorce from the EU. If this is the case, its stock market could do quite well. However, there are significant uncertainties over the ramifications of this split and there could be considerable disruption. At this stage, we risk falling foul of Harry Truman’s dislike of one-handed economists: on one hand, it could be this, on the other hand, it could be that. But on one hand, if there is a smooth transition, the outlook for the UK economy looks quite promising which should help produce potentially decent returns for the UK stock market. On the other hand, if the transition is more problematic and the implications of trade tariffs and customs inspections begin to impact the UK economy, the UK stock market could face a challenging twelve month. By our reckoning, therefore, we could see returns anywhere between the low single to high single digits.
All this does not provide a precise answer to the question of where expected returns lie for the coming year, underlining the binary forces at play that make predictions so difficult. After all, a nation has never divorced itself away from its main trading partner in the way that the UK is about to over the coming months.
Jason Broomer, Investment Director
Park Hall Financial Services Limited is authorised and regulated by the Financial Conduct Authority.
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