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Market commentary July 2008

By July 1, 2008No Comments

In January this year we asked “When can we expect persistently more buyers than sellers, because that is all we need for the market to make sustainable progress?”. We would not over-stress using technical analysis, but it is at its most powerful when you have regard to the simplest indicators to get a feel for sentiment, and the balance of buyers and sellers. For example, drawing a line joining a series of rising lows gives you a good sense of an uptrend (and visa versa with falling peaks), and a breach of that line suggests that, at a minimum, the uptrend is running out of steam.

In the chart below of the FTSE 100 index from 2003 to the present day, the uptrend from 2003 is shown with the blue line, as is the one from March 2008. (Sorry the quality is less than ideal)

A clear uptrend built from 2003 in the FTSE 100 index, and it peaked just above 6700 in June 2007 – a rise of just over 100%, though falling short of the all-time high in 1999 above 6900. Following this rising trend which lasted four years, the index has gone sideways and down for one year, and, to date, there has been a correction of 38% of this prior uptrend. It is possible to over-analyse history, calculating average downturns in price and duration, and extrapolating from this. Experience suggests it would be no surprise if the correction went on a bit longer and a bit deeper. For example, falling into the range of 4500-5000, and taking a few more months before the bottom is seen.

But is the latter now the “most likely” outcome? The strong bounce in the FTSE 100 index from a March 2008 low of 5400, to 6400 in May, was very encouraging. But we needed the index up through 6500 to break the pattern of falling peaks (in October and December 2007, as you can see joined by the blue line on the chart). As we write it is struggling to hold 5600 and a fall down through 5400 will reinforce the downtrend (blue line), and point firmly into the 4500-5000 range.

Sentiment became very positive in March 2008 when the rescue of Bear Stearns restored confidence in the financial system. But in May sentiment again turned negative because, although the worst of the credit crisis might be said to have passed (and we always felt that its impact would be focussed on a narrow range of sectors and people, and that the tools were there to see us through it), the overwhelming new factor is inflation. Unlike the credit crisis, inflationary pressures infect every household and every business in the UK, and this has spooked the market. Yet the risks are probably being over-stated.

Rising prices in the UK will have a deflationary impact, causing demand to fall across the economy, and prices too, except for those driven by global demand. In so far as oil is the major concern, there is already clear evidence that consumer behaviour is adjusting (US motorists drove 11billion fewer miles in March, the largest ever recorded decline), which will reduce demand. And a number of emerging economies have already begun to reduce domestic subsidies on oil prices, which will also dampen demand, and, eventually, prices. Even so, oil prices could yet breach $150 in the short term, triggering the stock market falls towards 5000.

None of this is a forecast. Rather it is a reassessment to manage our expectations in the short term, enable us to deal with falls through 5400, should they occur, with equanimity, and, as long term investors, encourage us to grasp buying opportunities.

Dennehy Wealth