Predicting where UK shares will stand 12 months into the future is a difficult task.
Inaccurate forecasts are typically associated with poor assumptions about key economic or political variables. Oil is a good example. Most observers agree that oil prices have a big effect upon shares. But figuring out where oil prices are heading is virtually impossible. Recall this commodity was recently priced well-above $50 per barrel. Some commentators confidently predicted that $70 or $80 oil was just ahead. Within a few weeks, prices fell to the low-$40 area.
If surprise swings of this magnitude occur within a month, how can anyone accurately forecast where prices will sit 12 months ahead?
Other important factors likely to affect shares in the year ahead include corporate profits, US and UK interest rates, the US budget deficit and growing trade deficit, dollar weakness, UK housing prices, the future course of inflation, China, terrorism and US-EU trade relations.
The list is lengthy. Many of the variables are unpredictable. The finest economic and political brains on the planet do not share a common view on most of them. Is there any wonder that most stock market forecasts for the year ahead are wildly inaccurate?
Historical analysis utilises a different forecasting approach. It ignores attempts to predict the unpredictable, choosing to rely upon recurring long-running historical trends. The trick here is to spot systematic patterns that seem likely to repeat themselves in the next 12 months.
Historical analysis is not without critics. Some observers believe historical analysis is unadulterated nonsense. The reason is that current prices are thought to reflect all knowledge about the present and all hopes, fears and expectations for the future.
If you spot a trend that occurred in 1945, 1965 and 1985, and is due for 2005, a critic will respond as follows. Either those prospects are already reflected in current prices or the trend has no current predictive value because different economic, political and social factors influenced that trend in the past.
Perhaps the critics are right. On the other hand, it is hard to ignore that fact that the US stock market often falls in the first full calendar year after a Republican wins the presidency. It is a trend that has run since 1928.
During this period, there were nine Republican victories. Prices fell in the first full year of their reign seven times. One of the two exceptions to the rule occurred in 1989, the first year of George Bush senior's presidency. Prices rose in the first nine months of 1989, plateaued for the next 11 months and then sharply declined in mid-1990.
There is no getting away from the fact that the US stock market often disappoints investors near the start of a Republican administration. The trend occurred in times of war or peace and periods of high inflation and low inflation.
Given the dominance of the US stock market, it takes a brave investor to bet on a rise for his or her home market in the face of possible Wall Street weakness in 2005.
In case you are wondering, first-year weakness is largely a Republican issue. The stock market's record in the year following Democratic victories since 1928 was seven advances versus just two declines.
Putting politics aside, another long-running historical trend also warns of possible trouble just ahead.
During the twentieth century, there were15 very big bear markets in the world's mature stock markets. They included Wall Street's painful drop in the early 1930s, London in the mid-1970s, Tokyo in the 1990s and 12 other serious declines.
These declines occurred in different decades and in countries with different political, social and economic conditions. Even so, most shared an important characteristic. All but one of the 15 bounce-back rallies ended within 19 months. The single exception to the rule was 30-month rally in Switzerland in the mid-1960s.
The limited life-span of the typical bounce-back rally is an important point to think about. The current bounce-back rally began on Wall Street in mid-October 2002. It is currently almost 27 months old, much older than average. It will reach its 30-month mark in mid-April.
Let us be quite clear about the significance of this data. History tells us absolutely nothing specific about the current rally. No one knows if America's S&P 500 will peak tomorrow, in mid-April, or if the rally will run a bit longer and set a new longevity record. But the message from the past is quite clear. History signals it is late in the day for the current rally. If the past is any guide, Wall Street is likely to peak at some point in the next few months. Given US stock market and economic dominance, London is unlikely to continue to rise if Wall Street begins to decline.
The bottom line: Prospects for long-term investors able to look beyond the next 12 or 24 months remain positive. But history also warns the current bull market rally will probably soon end. If the past is any guide, shares will end 2005 below their starting point.