How will the stock market perform in 2015? It’s anybody’s guess. The pundits are predicting that the FTSE 100 will break through the 7,000 barrier this year — but those are the same pundits whose predictions were confounded by the index’s 2.7% fall in 2014.
Uncertainty is heightened by the political and economic backdrop: a general election in the UK, Greece’s potential to blow the Eurozone up again, rising interest rates, oil prices, Russia, inflated asset prices in China… the list goes on and on.
Improving the odds
But what about the next five years? You don’t need 20/20 vision to make a fairly confident prediction that the FTSE will have risen by the year 2020. It’s well known that the longer you invest in equities, the lower the volatility of returns. To test the theory, I looked at the performance of the FTSE 100 over the 31 calendar years since its inception at the end of 1983. In eight of those years the index fell, a surprising 1-in-4 chance of the index dropping in any year, if the future is like the past.
However, the index fell just six times in the 27 rolling five-year periods since 1983, and four of those were in the period following the dotcom crash at the beginning of the century. Count that as one occurrence and the chance of the index dropping in a five-year period goes down to three in 27, or one in nine.
Two further things make long-term investing an even better proposition. Einstein called compound interest the eighth wonder of the world, and dividends have the same effect if you reinvest them. Barclays has calculated that £100 invested in 1899 would be worth £191 in real terms at the end of 2013 based on just capital growth, but £28,386 with dividends reinvested.
Secondly, if you invest over a long period, the chances are you’ll benefit from pound-cost averaging and avoid putting all your money in the market just before it crashes.
Stock-picking
On top of that, some judicious stock-picking — and giving bulletin-board pundit shares a wide berth – can improve your portfolio performance. With a long-term horizon and near-term uncertainty, I’ll especially be looking to top up on cornerstone shares: solid blue-chip companies that have dominant market positions, healthy balance sheets and reliable cash flow.
That includes shares like Shell (LSE: RDSB) (NYSE: RDS-B), GlaxoSmithKline (LSE: GSK) and Diageo (LSE: DGE). In five years’ time the current oil price drop might well look like a blip, whilst Shell has a strong balance sheet and strong cash flow to weather the storm and plenty of scope to boost profitability.
GSK is near its 12-month low, yet it has the scale to turn R&D into future profits, with lower-tech vaccines and over-the-counter healthcare businesses to provide ballast. Similarly, Diageo has been out of favour, not least hit by the Chinese clamp-down on lavish gift-giving. But its vertical integration, global brands and market power give it one of the best economic moats going, in a highly defensive sector.
