Will UK equities continue to climb?

UK equity prices have risen substantially over the past month alongside those in other developed markets, with the FTSE 100 up by around 3%, to 7,700 points. What’s more, this gain in the FTSE has not merely been a by-product of sterling weakness – the pound has risen against the dollar and held broadly steady against the euro. However, we doubt that the rally can gather much more steam, even if the economy performs fairly well, as we expect. Current valuations are stretched, and a secular weakness in UK earnings per share is beginning to weigh more heavily on cyclically-adjusted measures of valuation too. Meanwhile, our forecast for monetary policy to be tightened faster than markets expect in both the UK and the US is likely to filter through to more attractive yields on bonds. That could see the “hunt for yield” – which has driven up the price of riskier assets – subside somewhat, reducing what investors are willing to pay for equities. We think the FTSE 100 will finish the year at 7,600, a bit below its current level.