After a disappointing 2014, what does 2015 have in store for investors?
After an impressive 2013, in which the FTSE 100 index returned more than 15% (including dividends) to investors, 2014 has turned out to be something of a damp squib.
At the time of writing the FTSE is down around 150 points from its closing price of 2013. And while taking cash dividends into account bumps that up to a 2% profit, that's still disappointing when there had been talk of the index hitting a new record high.
So what lies ahead in the coming 12 months?
Good economic news
According to the International Monetary Fund (IMF), the global economy is forecast to grow by 3.4% in 2015, a whisker higher than the 3.3% expected for 2014. The UK is expected to do well, with a 2.7% improvement in our national output.
There's also good news on the employment front, with unemployment dropping to its lowest level in six years in October. And inflation has fallen sharply over 2014, to just 1%.
All of these factors could mean people are a little better off in 2015, which may translate into higher earnings (and therefore share prices) for many businesses.
Shares are not expensive
In historic terms, UK share prices are not overpriced. Over the long term, the average rating for the London market is around 16 times earnings. Right now, this price-earnings ratio is below 14, a level that suggests further upside to come for share prices.
[SPOTLIGHT]With cash interest rates still so low, more people may be tempted to turn away from mediocre savings accounts and put their money into shares that offer juicier cash dividends and offer the prospect of capital gains.
Bad times ahead for bonds
While the FTSE 100 failed to exceed its all-time high this year, bond prices soared to incredible levels.
Since 1982, bond prices have climbed inexorably and, as a result, bond yields are now among the lowest in recorded history. For example, a 10-year gilt (UK government bond) pays a fixed coupon of a feeble 1.85% a year, even lower than the 2.18% on offer from a 10-year US Treasury.
Such ultra-low bond yields suggest that, in the not-too-distant future, bondholders face a dire reckoning. With the UK and US both expected to start raising interest rates next year, bonds appear to be tremendously overpriced. Higher economic growth and tighter monetary policy are a toxic combination for fixed-income investments.
Beware of volatility
Volatility is a way of life for stock markets - in 2014 alone, the FTSE 100 moved from a high of 6,905 in early September to a low of 6,073 in mid-October.
Given current geopolitical instabilities (such as Russia/Ukraine, Islamic State, Ebola, the plunging oil price, and tensions between China and Japan), any kind of wildcard could hit financial markets next year.
The importance of diversifying
No one really knows what 2015 holds for shares, stock markets or national economies. But you can cover yourself against the worst by investing across a wide range of asset classes and economies. You reduce the overall risk and volatility of your portfolio, which means that you'll be in a better position to ride out whatever unexpected challenges the new year throws your way.
More on investing:
What the stock market did in 2014
The most popular funds of 2014
Pension providers' high fees exposed