Brokers bullish despite warnings of economic slowdown

As the FTSE 100 once again marched higher yesterday, stockbrokers across the City predicted yet more gains for equities in 2007, driven by corporate activity, benign economic conditions and strong newsflow. London's blue chip index has registered a 10 per cent advance so far this year, closing 55 points higher at 6,245 yesterday. This comes on top of the 17 per cent jump the FTSE 100 enjoyed in 2005 and leaves it trading within a whisker of its highest level for six years.

Of strategists polled by The Independent, only two believe that the index will end 2007 lower than it currently stands.Hargreaves Lansdown, the Bristol-based broker, is most bullish on London shares and expects the FTSE 100 to hit 7,000 before the end of the year. That would be a new high for the index, a level not seen since December 1999 when the blue chips hit 6,930. Investors will certainly be hoping that Lewis Charles Securities does not prove to be one of the top forecasters next year. The broker is predicting the FTSE 100 will close 2007 at 6100, showing no growth over the year. JP Morgan is even more bearish with a 5850 forecast, the lowest of the brokers surveyed.

However, most strategists view UK and European markets as good value and expect a continued re-rating of equities. The price to earnings ratio of the London market, about 12.3 times forecast 2007 earnings, remains close to historical lows.

"We expect European stock markets to continue to rally in 2007. Valuations are supportive for stocks with a generous yield gap compared to bonds," said Lehman Brothers' strategist Ian Scott in a research note previewing the year ahead. He also expects plenty more mergers and acquisitions over the next 12 months pointing out that M&A activity in Europe is well below levels seen back in the start of 2000.

Alongside City analysts, money managers are also upbeat about UK and European stocks going into the new year. Paul Feeney of Gartmore Investment Management said: "Next year we expect market conditions to continue to favour equities. Although its likely that global economic growth will be slower in 2007 than in the last couple of years, overall the growth trend should remain positive."

Mr Feeney believes that although short-term interest rates have increased in a number of markets, long-term rates remain at historical lows with plenty of liquidity in the system. This is particularly significant as it means banks are still going to be happy to lend money and provide the financing for private equity buyouts and M&A deals that have been a key driving force behind equity gains in 2006.

After a poor year, brokers are also expecting better things from the largest UK companies in 2007. BP and Shell both look like ending the current year in the red, as do HSBC and GlaxoSmithKline. Investec Securities is looking for a rotation of money into the largest stocks. Merrill Lynch expects to see the emergence of consumer consumption in developing markets as an important trend but believes the dollar will remain weak. Common themes across broker outlooks for 2007 include expectations of another mild market correction during the year and caution over the banking sector.

JP Morgan is among those bearish on the banks. In a research note to clients yesterday it warned that the UK sector offers below average growth relative to the continent and long-term structural issues like the housing market could put valuations at risk in the coming year.

There are other potential banana skins on the horizon apart from a weaker US dollar. The amount of money private equity companies are borrowing to do deals is a worry and, should the bubble burst, it could knock the markets for six. The geopolitical risks to the markets are obvious, but a major escalation of conflict in the Middle East or a major terrorist attack in the West appears to have been discounted by investors.

This time last year, most analysts erred on the side of caution when making their predictions for the year-end. JP Morgan proved to be excessively downbeat and picks up the wooden spoon for its 2006 FTSE 100 year-end forecast. The US investment bank gave a target of 5,300 to start and although it was upgraded to 5,750 in October, it proved too little too late. Investec was also bearish, with a 5,500 prediction.

Despite the solid gains achieved by UK shares in 2006, investors needed to go to some of the world's more exotic stock markets if they were to capture the best performances. According to Bloomberg, Peru's General Index was top performer, showing a 166 per cent rise in local currency terms. This partly reflects relief that elections this summer returned the centrist candidate Alan Garcia and not the radical left-winger Ollanta Humala who had the backing of Venezuela's Hugo Chavez and had campaigned for greater state control.

However, the key driver has been the rising price of raw materials. Mining companies account for more than half of the Peruvian index and have helped the country's economy expand by around a third since 2001.

Vietnam's Ho Chi Minh Stock Index and the Venezuela Caracas Stock Exchange came a close second and third rising 143 per cent and 141 per cent respectively which goes to show that left-wing regimes can also be lucrative.

Given the turmoil in the Middle East, few will be surprised by the poor performance of its markets. Saudi Arabia's Tadawul All Share Index lost 53 per cent of its value, Dubai General Index dropped 43 per cent, the Abu Dhabi General lost 42 per cent, and the Jordan Amman General fell 32 per cent as the oil-fuelled boom of recent years imploded. Given the Israeli bombardment of Lebanon and the possibility of civil war, it is amazing the Beirut Blom Index only fell by 10 per cent.

Thailand's decision to restrict capital flows earlier this month knocked more than 20 per cent off the Thai SET Index. However, it quickly recovered after the country's military government reversed the decision days later and is now down just 3.5 per cent on the year.

It goes to show that in today's world it is often financial markets that set policy, and not governments.