More QE will support the FTSE 100

SINCE traders returned to work at the start of September, the FTSE 100 index has been climbing steadily higher. Having fallen to as low as 4,805 in early July, the blue-chip index is now trading around the 5,700 mark and there is every expectation among market participants that equities could continue to gain ground. However, spread betters should not expect to make a fast buck from going long on the FTSE 100. As Capital Spreads’ Simon Denham says: “We get to a new level and then spend a week or two just meandering around until a piece of news (generally from the United States) takes us to a new region.” This has been happening since about the middle of July.

But analysts are still positive about the outlook for UK equities in spite of the risks to the British macroeconomic environment. For example, Citigroup European equity strategists maintain their target for the end of 2010 of 6,000. This provides almost 300 points of upside from Friday’s closing level of 5,703.37. Spread betters should be watching out for resistance levels at 5,740-5,745 and then at 5,760-5,765. Near-term support levels where stop-losses could be placed are at 5,705-5,710 and at 5,680-5,685, according to Denham.

There are three reasons why the FTSE 100 should continue to rise despite the uncertainty about Western growth. First, and perhaps the most well known, is the index’s exposure to emerging markets. More than 70 per cent of FTSE 100 revenues are generated overseas so the index should – at least in theory – remain resilient to any renewed downturn in the domestic economic outlook. However, it has been increasingly clear that markets are still extremely sensitive to economic data and speeches and have the capacity to surge or drop if the figures are not precisely as expected. Ahead of Wednesday’s spending review, this should be an obvious risk to any long FTSE 100 trades.

Second, there are positive expectations for the ongoing corporate earnings season both this side of the Atlantic and in the US. This should boost stock markets – or at least minimise the downside risk by preventing them from falling further.

Third, the growing likelihood of a second round of QE – at least in the US and possibly here in the UK – is expected to support asset prices. For a start, this “Bernanke put” will boost the market’s appetite for risk. With bond prices suggesting that the market is pricing in deflation, even a modest uptick in price trends would have significant implications for asset allocation and equities would be the biggest gainer, says Morgan Stanley’s Graham Secker.

“The huge amount of liquidity sloshing around the global financial system right now is predominantly sitting in bonds; while this is understandable in a world worried about deflation, such a position is much harder to justify if investors start worrying about rising, not falling, inflation,” he explains. He concludes that if inflation does ultimately starts to rise, it will be good news for equities initially.

A poor earnings season or a Federal Reserve U-turn on further QE could derail equity performance, but in the absence of these materialising, the FTSE 100 should continue its climb in the fourth quarter.