Will stocks and shares continue to do well in 2006?

21 December 2005

Stock markets around the world have enjoyed a pretty good run in 2005. In Britain , for example, the FTSE 100 index of the biggest companies is up more than 15%. “We began 2005 heavily overweight equities and have not been disappointed. Equities have risen sharply across all major markets,” said Paul Niven of F&C Asset Management, one of the biggest fund managers.

Shares have been bolstered by strong corporate earnings and resilient global growth. Equities also seem relatively cheap. Niven said: “Share prices have not kept pace with earnings growth, so although markets have ended the year higher – equity valuations have actually not become any dearer.” The big question is: will stocks and shares continue to do well in 2006? Or should we take our profits and run – or at least stuff the money in a savings account?

Stuart Fowler of AXA Investment Managers is keeping faith with UK equities. He said: “We expect another good year for the stock market in 2006. The market's valuation is OK, the international economic outlook is broadly supportive, and takeovers are likely to be a feature again - corporate activity always gets the market's juices flowing.” He even dares to hope that investors might get over their infatuation with property. “The stock market has been rising steadily since March 2003. Surely there must come a time when the love affair with buying houses wanes in favour of shares again.”

Fund managers at Jupiter are also optimistic about the prospects for UK shares next year – or at least some shares. John Chatfeild-Roberts, a fund analyst at Jupiter, said: “I am positive on the outlook for the UK stock market, although I do not favour consumer exposure.” He is worried that mounting debts and bigger utility bills will curb consumer spending. So he would avoid sectors such as retail. Shares in smaller firms have beaten their bigger rivals over the past year, but a number of experts tip larger companies over smaller firms in 2006.

Bob Yerbury, chief investment officer of Invesco Perpetual, said: “The gap between small and large firms is narrowing and I am cautious about the prospects for some smaller firms.” Chatfeild-Roberts believes the trend towards larger companies will gather pace in the year head. It might also be time to invest in a tracker fund. He said: “The growing dominance of oil stocks will make it harder for the less-successful active managers to beat the UK index.” Oil stocks have shot up over the past year - and David Scott of Redmayne Bentley, the stockbroker, remains keen.

Chatfeild-Roberts also tips Russia and emerging Europe as beneficiaries of the high demand for oil. Graham Secker of Morgan Stanley, the investment bank, takes a more cautious view of the UK market. He expects shares to be broadly flat over the next year and would probably put his money into a high interest savings account. If you share Secker's rather gloomy view of the future for the UK stock market, you might want to look further afield – and experts are excited about Japan and continental Europe .

Chatfeild-Roberts said: “The Japanese economy is on track for its fourth consecutive year of growth, property prices are recovering, deflation is set to end soon and, most importantly, domestic demand is beginning to pick up. Investors have been flooding into the country over the past year on the back of this positive news, but the recovery story still has a long way to run.”

F&C is also confident about Japanese equities. In fact it believes the markets of Japan and continental Europe will lead the pack in 2006, despite strong returns already during 2005. Niven said: “The nascent European and Japanese economic recoveries will continue, taking up the growth mantle from the US and leading to a more balanced global backdrop.”

So, we know where's hot to invest, but where's not to invest? All the experts agree: avoid America in 2006. “The US consumer kept on spending during 2005, despite rising oil prices and the difficult news flow from Iraq . But we expect that the American economy is the one most likely to disappoint,” said Niven. He points out that US interest rate expectations have turned sharply bearish, pricing in at least two more hikes during 2006.

Max King, global investment strategist at Investec Asset Management, agrees: He said:  “ The principle factor affecting the global economy in 2005 is the probability of a slow-down in the US , caused indirectly by higher interest rates and energy costs.” America might be the biggest stock market, but it is not necessarily the best – at least not for the coming year.