The FTSE 100 fell 6 per cent last year, which was bad news for buy and hold investors. Its performance compared poorly with the major US indices: the Dow Jones Industrial Average managed a 5 per cent gain, while the broader-based S&P 500 index ended flat. Nevertheless, the UK index easily outperformed the German Dax (down 15 per cent) and China’s Shanghai Composite, which lost 21 per cent over the course of the year.
There’s been a good start to 2012 with investors apparently happy to increase their exposure to UK equities. Many now believe that the world has seen the worst of the financial crisis. Recent economic releases from the US have come in better than expected, while China’s GDP growth remains robust and inflation continues to moderate, reducing fears of a Chinese “hard landing”. As for Europe, investors have shrugged off ratings agency downgrades and lowered growth forecasts. It appears that all bad news is now priced in.
Risk appetite is currently strong thanks to the expectation of further stimulus from the Bank of England next month, while the ECB looks like expanding its long term refinancing operations to help backstop troubled European banks. The IMF wants to build a larger bail-out fund, and it’s even possible that the US Federal Reserve is open to additional stimulus measures, once it finds a way to spin it positively.
Yet these interventions show that there are still fundamental problems with the global economy and our financial institutions. Until these are dealt with, the outlook remains uncertain.
From a technical perspective, the FTSE 100 dropped below the 5,800 level in late July 2011 on the basis of the omnipresent escalating debt crisis in Europe.
Only one attempt was made to regain this level in late October last year and this failed to break above 5,783, which coincides with the 76.4 per cent Fibonacci retracement level from the May highs to the August lows. The FTSE is at present retesting this resistance point and only a convincing break and close above would see 5,900 and upwards in the crosshairs.
The UK has a difficult balancing act in stimulating growth, while protecting its AAA rating through massive savings on public spending. The economy is at a critical stage and is predicted to have shrunk by 0.1 per cent in the final quarter of 2011.
The largest constituents of the FTSE 100 on a sector basis are financials, miners, oil and gas. These are sectors that generally do well when the economy is growing, not contracting.
The ECB’s long term financing operation has, for the moment, helped to allay the funding problems facing the European banking system. Any escalation of the financial crisis within Europe may weigh heavily on the FTSE given the UK financial sector's exposure to European banks and sovereign debt.
Inflation is showing signs of easing, so a further extension of the QE programme in the early part of this year is largely anticipated. This could easily give the equity markets and ergo the FTSE 100 a boost. Global demand looks set to remain weak, so even with a weaker pound, the FTSE has a difficult year ahead.
Stock markets may have surprised a few people this year by the strong start we have seen to trading after the Christmas break. While we still have the dual worries of the ongoing Eurozone crisis and slowing economic recovery, some would view it as somewhat irrational – but nowhere is it written that markets have to be logical.
Investors appear to have a more relaxed approach to the problems of the Eurozone and, while an absolute solution does not appear to be that much nearer, it does feel like markets have now discounted much of what we know about this problem and are looking further ahead. Ignoring the slowing economic recovery is a little harder to understand – the risks of a double-dip recession are far more likely than they were 12 months ago, but the FTSE 100 is only around 100 points lower over the past 12 months.
In the short term at least there still seems to be an appetite to buy on the dips, so it does not seem too unrealistic to see the 6,000 level challenged in the first few months of 2012. The 5,600 level has proved very resilient to any shock,s so for now at least the market appears well supported.
The old adage has it that bull markets climb a wall of worry – so it seems unlikely to see the rate of momentum for the FTSE 100 at the moment continue through 2012, bearing in mind we have the same problems that weighed last year. We shouldn’t let the enthusiastic start to trading this year lull us into a false sense of security, so it is difficult to see significant progress through 6,000 as the year unfolds.
The FTSE 100 is in a unique position at the present moment. On the one hand we have a bullish bias with a potentially bullish pattern in development and at the same time we have the index approaching a resistance level. Having cleared past the initial hurdle of 5,600, which held back the index since October 2011, the next upside objective of 5,820 is within easy reach. After achieving 5,820 it is likely that the FTSE will aim for the psychological level of 6,000.
However, the reach for 6,000 may require several attempts to break past 5,820 first. The immediate picture sports a potential five wave pattern from the November 2011 low. This would suggest that we are likely to see a pullback after reaching 5,820, before attacking the 6,000 level. Also, the current move up is a correction against the main bearish trend since the July 2011 high. This means that there is likely to be a larger degree correction in store for the bears to come along and spoil the fun for the bulls. This is most probably going to occur during March to April, as there is a time spiral window during these months. Once the FTSE creates a reversal pattern at the cited resistance levels the correction is likely to be greater than 10 per cent and could see the FTSE trade back towards the 5,200 area.
What we can count on is that we will most likely have volatility and range expansion picking up over the next few months, creating ample trading opportunities for both bulls and bears alike.