Investors started 2011 in buoyant mood and if our history books are any guide they have good reason to be bullish. The third year of the US Presidential term has proved a goldmine for equities as the current administration attempts to make conditions as favourable as possible for the electorate. In fact, the Dow Jones Industrial Average has risen in pre-election year every time in the past six decades and by an average of almost 18 per cent since the mid-1960s.
And given the high correlation between movements on Wall Street and the London equity market, it's hardly surprising that this positive sentiment rubs off on investors here. In fact, the FTSE All-Share has done even better, rising by an average of 28.4 per cent in the President's third year of office with not a single down year since 1967. That's 11 winning trades on the trot.
Stock markets on both sides of the Atlantic also have a tendency to do well when there is a marked divergence between current and future consumer confidence expectations in the US based on the highly-regarded Confederation Board's monthly consumer confidence index. Stock market historian David Schwartz notes that: "There have been 11 occasions since 1967 when the gap between the current and future indices widened to at least 50 points. A bull market was under way each time and continued for at least one more year on every occasion bar one. The single exception occurred in 1975 when the bull market ended nine months later - a near miss." That's important right now because Mr Schwartz also points out that: "The gap between current and future expectation ratings only broke through the 50 point barrier in November due to a sizeable increase on the future expectation index. If the past is any guide, it bodes well for investors in 2011." As the UK is a major trading partner with the US, then rising consumer confidence levels in North America - consumer spending accounts for over 70 per cent of US GDP - is a major positive for UK plc, which is already benefiting from strong uptrends in exports and manufacturing.
There is another reason why global stock markets could make further headway over the course of this year: the Federal's Reserve second round of quantitative easing. By mid-January the US central bank had only completed a third of its $600bn (£387bn) buy-back programme of US Treasury securities in an attempt to push down long-term interest rates, inflate asset prices and reverse the declining price pressures in the economy. As analysts at Charles Stanley note: "These stimuli together with zero interest rates should give the US economy another shot in the arm and GDP growth of some 3.5 per cent is expected in 2011. The hope is that consumption and the jobs market could start to improve in 2011. The implications of the Federal Reserve's strategy are higher inflation and hopefully higher GDP which should be better for equities rather than fixed income." With the S&P 500 rated on a 2011 PE ratio of 13 - assuming of course that EPS grow by 13 per cent as forecast - this offers scope for further upside in US equities which would also be positive for the UK market.
And even though our domestic economy is facing stiffer headwinds with higher taxes, an austere Budget and the bail-out cost of Ireland are set to dampen economic growth - the Office for Budget Responsibility (OBR) downgraded its 2011 GDP forecast slightly from 2.3 per cent to 2.1 per cent - the outlook for equities still remains favourable. For instance, the FTSE 100 is priced on a modest 2011 PE ratio of 10.8 - assuming 16 per cent EPS growth - and offers a prospective dividend yield of 3.4 per cent. Even stronger growth is expected from the FTSE 250 which trades on 14.5 times 2010 earnings, falling to 12 times if earnings rise by 20 per cent as analysts predict. Strong earnings momentum and a potential pick up in mergers & acquisitions (M&A) activity, which is normally a feature of maturing bull markets, should both offer tailwinds for UK equities.
However, investors should not expect an easy ride as it is likely that markets could prove just as volatile as last year as the ongoing eurozone sovereign debt crisis has clear potential to raise risk aversion levels. As a result the best returns are likely to be made by nimble stock pickers taking advantage of buying opportunities as they present themselves throughout the year which makes our comprehensive guide to spotting the winners in the FTSE 350 as valuable as ever.
