Investors have been warned by one of the City’s best forecasters that the bull market could come to an end next year, with the FTSE 100 falling for the first time since 2002.

Morgan Stanley, the investment bank that correctly predicted the onset of the global credit crunch in June, and then the market bounce in August, is recommending clients bank their profits from equities and shelter in cash ahead of the downturn.

The prediction came as Mervyn King, governor of the Bank of England, issued a highly unusual warning about the risk of a fall in share prices.

In the Bank’s November inflation report, King said the strength of global stock markets over the past three months, during which the Footsie had surged by nearly 8 per cent, was “surprising” given that banks are writing off billions of pounds of losses from the American sub-prime mortgage meltdown.

Last week, Barclays, for one, was forced to admit a £1.3 billion loss because of its investments in risky debt linked to the US home-loan market.

The FTSE 100 index of Britain’s leading shares closed down 9 points last week at 6,291 as nerves spread to the rest of the banking sector.

Morgan Stanley, which was one of the top 10 economic forecasters last year in a Sunday Times Business survey, predicts the Footsie will rally to 6,550 by the end of this year, before falling 4 per cent to 6,300 by the end of 2008. It would be the first negative year for five years and would mark the end of the bull market, which has seen shares surge 91 per cent since their trough on March 12, 2003, just before the Iraq war.

More worryingly, Morgan Stanley thinks there is a 40 per cent chance the Footsie will drop to 5,350 next year – a slide of 18 per cent. Its “bull” case is that the index will continue its rise to 7,500, but the investment bank thinks the bear scenario is twice as likely.

Graham Secker, Morgan Stanley’s UK equity strategist, said: “There is a growing risk this decade’s bull market is ending. There is a good chance that America will go into recession, and possibly that Britain will follow. While the Bank of England may cut interest rates twice next year as a result, we don’t think that will rescue the markets. With the risk of recession increasing, we would rather be in cash than equities.”

Advisers recommend that investors bank profits from funds in hot sectors that have tripled during the bear market in favour of cash or unloved markets such as America.

Gary Potter of Thames River, an investment boutique that selects the top fund managers from across the markets on behalf of clients, said: “2008 is shaping up to be a difficult year and while I am not bearish, I am cautious.

“At times like this, investors should look at their investment portfolios and take profits from areas that have done well – Asia, emerging markets and smaller companies.”

Over the past five years, global emerging-markets funds, which have been one of the most popular sectors in recent years, have soared 268 per cent, while European smaller-com-panies funds are up 216 per cent and Asian funds, excluding Japan, have surged 196 per cent.

“The question is where to put the money,” Potter said. “We currently have about 15 per cent of our portfolios in cash, compared with about 5 per cent for our benchmark index.

“But if you want to stay in equities, we would favour funds that focus on big blue-chip companies.

“And with the dollar weak, the US equity markets could be a better bet than they have been for some time.”

There are plenty of analysts who remain optimistic about the equity markets – although even they admit we are in the late stages of the bull market.

Robert Parkes, UK strategist at HSBC’s investment bank, said: “We still think the market will move higher next year, to 7,500. Company profits are holding up well, the interest-rate cycle favours equities and the global economy is still robust.

“We certainly don’t see the bull market coming to an end.”

However, Secker and his colleague Teun Draaisma are worth listening to because they have had an enviable track record this year. In June, with markets at seven-year highs, Draaisma warned that a correction was on the way – a few weeks before the credit crunch struck.

In August, he concluded the plunge had gone far enough and advised clients to start buying – three days before the market troughed.

Draaisma said: “Suppose that in 2004 someone had described today’s situation to you? He would say that oil is at $100, the pound is at $2.05, profit margins are at all-time highs, it is the first quarter with negative US earnings growth, house prices are falling in the US and the UK, while bank-balance sheets are being severely questioned. Despite this, equities are within 6 per cent of their peak. What would you do with your equity holdings, buy or sell?”

He thinks that investors should be braced for four years where share prices are flat, as they were after the stock market crash of 1987.

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