For my 2015 FTSE 100 forecast I thought I would bend over backwards even more than usual to highlight just how uncertain the future really is, and how pointless most forecasts are (especially those that pick a single figure like 7,500 as a target for the end of the year).
Forecasting the FTSE 100 over the long-term
For a start, I won't be picking a single figure as my guess (as that's all they ever can be) for where the FTSE 100 will be at the end of the year. In fact, I won't be making any forecast for where the market will be at the end of this year at all.
Instead I will take a more realistic approach and simply point out the range of values that we could reasonably expect the market to reach by 2025.
Why “forecast" all the way out to 2025? Because I think a 10 year forecast is more useful for investors than looking just one year ahead. That's true whether the investment is a buy-to-let flat or a FTSE 100 company.
Assumption 1: Real earnings and dividend growth at 2%
My first assumption for forecasting the FTSE 100 out to 2025 will be that total earnings and dividends for the largest 100 companies will grow about 2% faster than inflation each year.
Historically that's quite conservative, and given that nobody really knows how those companies will grow in the future it makes sense to be conservative.
Assumption 2: The FTSE 100's CAPE valuation will follow historic norms
Equity markets are typically valued in terms of price relative to earnings, in other words the good old PE ratio. However a better approach is to use CAPE, the Cyclically Adjusted PE ratio.
CAPE uses 10-year inflation adjusted earnings instead of current earnings because averaged or “smoothed" earnings provide a much more stable figure against which to compare today's price, which in turn makes CAPE a much better predictor of the future than the standard PE.
Today, with a market value of 6,400, the FTSE 100 has a CAPE ratio of just under 12, and its average real earnings over the past 10 years have been 537 index points (it's easier to work with index points rather than trying to convert index points into pounds, although that is possible).
Assuming 2% real growth and 2% inflation gives a cyclically adjusted earnings figure of almost 800 by the year 2025, and that's the figure I'll use…
