THE FTSE 100 index of leading shares could surge to a record high of 7,000 next year, say City experts, smashing through the previous peak of 6,930 reached in December 1999.

The Footsie ended 2006 on a positive note, rising 173 points in the final month of the year to finish at 6,221 on Friday — just shy of its highest level for five-and-a-half years. Over the whole year the Footsie climbed 10.7%, and was up 14.8% when income from dividends is included.

Most fund managers and analysts expect 2007 will be another year of healthy gains for UK shares. A survey of Footsie forecasts by The Sunday Times reveals experts are predicting an average rise of 7% in 2007, taking the index to 6,643 in 12 months’ time. Once dividends are included, returns could be 10%.

Some pundits are even more positive. Richard Hunter at Hargreaves Lansdown Stockbrokers expects a gain of 13%, excluding dividends, taking the Footsie to 7,000. He said: “Strong corporate earnings, fevered takeover activity and plenty of cash looking for a home to invest will drive the index to record levels.”

Investors have flocked back to the stock market in 2006 and are entering the new year in buoyant mood. Sales of investment funds have rocketed to levels not seen for five years. The Investment Management Association estimates that more than £14 billion of unit trusts were sold to investors this year, the highest level since the height of the dotcom bubble in 2000.

Mitchell Clayton, 48, an investor from Liverpool, is happy to stick with his investments in anticipation of a good 2007 after strong returns this year. The fund he invests in, Schroder UK Alpha Plus, has risen 23% over the past 12 months. The fireman said: “Similar returns in 2007 would be fantastic.”

If the market continues its climb next year, it will be only the sixth time since 1900 that UK shares have risen in five consecutive years, according to Barclays’ Equity Gilt Study.

But fund managers are upbeat because UK shares still look cheap, despite the healthy gains of the past 12 months.

Grant Lindsay, head of equities at Alliance Trust, said: “Equities offer good value when compared with other asset classes such as bonds and property.”

One of the most widely used measures of stock-market value is the price/earnings ratio. The Footsie has a prospective p/e for 2007 of 12.5 — lower than the historical average of about 14.

Edward Bonham-Carter at Jupiter Asset Management thinks the market could also receive a fillip from takeovers. Mergers and acquisitions usually boost sentiment among investors, and have been one of the key spurs to growth this year.

He said: “The drivers of takeover activity — the low cost of debt, strong corporate cashflow and attractive valuations — remain in place, which will allow the bull market to continue.”

While experts are broadly optimistic about shares, some think it could be a rocky ride. Stephen Whittaker, who manages the New Star UK Growth fund, thinks markets could be due a repeat of May’s shake-out when shares plunged 9%. He said: “There could be increased volatility next year given that the latter half of 2006 has produced several months of relative calm.”

The biggest threat to shares is the slowdown in the American economy, which is already well under way. Most commentators are counting on a soft landing, but if the US falls into recession, it will be bad news for equity markets worldwide.

Neil Woodford, a fund manager at Invesco Perpetual, said: “Clearer evidence is emerging that the US economy is weaker than expected. This weakness is not just a function of the slowdown in the housing market, but is also spreading through the consumer and manufacturing economy as well. Therefore, it is right to tread carefully.”

Even if the UK stock market shrugs off what is happening in America there are some domestic factors that could have a destabilising effect.

Although a record number of shoppers have hit the sales in the past few days, there are concerns that over-indebtedness, higher utility and council tax bills and rising interest rates will begin to bite, causing a slowdown in consumer spending.

Interest rates have already risen twice this year and another quarter-point rise is expected in the first three months of 2007. Some believe the Bank of England could hike rates again later in the year, which would be bad news for shares because it would raise the cost of borrowing.

Given these potential risks, many fund managers recommend investing in defensive companies that can maintain their market position even when the economy is slowing. Woodford likes Vodafone, the mobiles group, Glaxo Smith Kline, the drugs firm, and oil giant BP.

Analysts also believe large blue-chip companies are worth buying because they look the best value after a strong run by smaller and medium-sized firms.

The FTSE Small Cap index has beaten the Footsie for the fourth year running, rising 18.2% before dividends. The FTSE 250 index of medium-sized firms has soared 27.1% to 11,178, well above its peak during the tech bubble.

Gavin Oldham at The Share Centre, a stockbroker, recommends oil giant Shell and Prudential, the insurer.

If you would prefer to invest in a fund and let a professional manager make the decisions, Anna Bowes at Chase de Vere, an adviser, suggests Merrill Lynch Special Situations, Standard Life UK Opportunities and Axa Framlington UK Select Opportunities. These schemes have wide mandates so the managers can invest wherever they see the best value and investment returns.

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