I’ll start this UK stock market forecast with the FTSE 100 as that’s the index most people think of when they think of the UK stock market.

But before I begin – a couple of points:

  1. I only make long-term forecasts, so I’ll be talking about what the market might return over the next ten years rather than the next year or two.
  2. By “forecast” I mean the Expected Value of the market’s total return. In other words, a best guess of the average return the market would produce if we could run through the next ten years multiple times (which, according to the known laws of physics, we can’t).

FTSE 100 forecast: Expected ten-year total return of 10% a year

Today the FTSE 100 stands at 6,350 with a dividend yield of 3.8%. That’s slightly higher than its long-run average yield, which is closer to 3%.

As a result of that slightly high yield the FTSE 100 is, at least from that point of view, slightly cheap and somewhat attractively valued relative to historic norms.

My preferred approach to forecasting the stock market’s return is to assume normal inflation, normal real (inflation-adjusted) dividend growth and a normal dividend yield.

So here are some basic assumptions:

  • Inflation to 2025: 2% a year
  • Real dividend growth to 2025: 2%
  • FTSE 100 dividend yield in 2025: 3%

Those are all reasonable and fairly conservative assumptions and they represent my best guesstimate at what the next decade might look like.

With today’s FTSE 100 at 6,350 points and with the dividend yield at 3.8%, its dividend payment is currently 244 index points.

If that dividend grows by 4% a year for ten years (2% inflation plus 2% real growth) then by 2025 the dividend will have reached 344 points.

If the FTSE 100 has a 3% dividend yield in 2025 then with a dividend of 344 points it will have reached a level of 11,470.

That’s equivalent to a 6% annual capital gain, which is 2% from inflation, 2% from real dividend growth and 2% a year from the contraction of the dividend yield (and therefore the expansion of the ratio between price and dividend).

On top of that capital gain we can reasonably expect an average dividend yield of between 3% and 4%, giving a forecast total return to 2025 of just under 10% a year.

Another valid approach to forecasting the market’s return is to use cyclically adjusted earnings, i.e. the…

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