The FTSE broke above the previous high (6612.2) an indication that the fifth wave up is underway. The FTSE was helped by Wall Street recording a new all-time high and receding political uncertainty in the UK. We now have a new PM but there is still work to be done with the EU. Furthermore the market was boosted by expectations that the Bank of England will announce more stimulus on Thursday.
Well, I won’t comment on stimulus because it is like a magic wand, we know it’s a trick but it works. Meanwhile the earnings season is underway and as always we can’t say if earnings will beat estimates but the market tends to rise during the earnings season.
This time however, and because the market has shot up in the last two weeks, the FTSE is already overbought based on the Top 20 Differential and 13-day BTI. When these two indicators are overbought the probability of a decline is high.
As you can see there is lots of positive for the market to continue to rise but at the same time the market has gone up too fast and the FTSE is overbought. In that situation you want to go long but after a decent pullback as it is not recommended to buy an overbought market.
The rally from the post referendum low is wave A in five waves [i,ii,iii,iv,v (circle)] and we are now in the final wave up [wave v (circle)] and the indicators are overbought. This is why it is not the ideal time to go long. The time to go long will be after wave B, sometimes in the next two weeks. Here we have a medium term rally in three waves [A,B,C], the next move after wave B will be wave C up. The target is near 6900.
Today we have the nonfarm payrolls report (NFP) at 13:30, this could shake the market and if the number is weak the FTSE will drop to 6460. As always it’s not recommend to trade ahead of the report if you have a tight stop loss. While sentiment is bullish and the lower pound has boosted the earnings of FTSE 100 companies, there are risks from the fallout of Brexit and from China where the Yuan is falling and I believe once the current rally is done the bear market will resume as investors will turn negative on the global economy. The fragile economic recovery has been derailed by Brexit, furthermore the Yuan has fallen sharply in recent months but investors have ignored the warnings. You will recall the low Yuan caused the stock market sell off at the start of the year, well the Yuan is lower and making new lows. Something to watch.
Sentiment is bullish judging by the strength of the rally post Brexit. Rallies of this magnitude will impact sentiment, the longer and the stronger the rally, the more bullish people become. The rally has taken many by surprise including me, the actual cause is not clear but I suspect it’s a combination of factors including short covering.
The fundamentals have deteriorated, stimulus is back, furthermore I suspect a very large proportion of investor took short positions post Brexit well below the top as they did not believe the FTSE would go back up. When the FTSE rallied they had to cover theirs shorts and if we are talking about a large number of orders this will fuel the rally.
But the fundamentals are worse than they were pre Brexit so I suspect the downtrend will resume. Sometimes the market will produce some weird moves that not many people expect, fortunately these weird moves don’t occur very often but we have to live with them. The question now is, will the decline resume below the previous high (6380.5) or will the FTSE rally to 6600 before the decline start?
The day before the referendum I predicted a rally to 6600 prior to the bear trend resuming, this is still a possibility. But right now the high at 6380.5 remains intact, as long it remains intact we cannot rule an immediate decline and a resumption of the bear market.
But if the FTSE breaks above 6380.5 the FTSE is expected to climb to 6600. This scenario is possible because sentiment has turned bullish and the pattern on the S&P can be interpreted as the start of medium term rally. In any case the rally won’t be in a straight line because it’s a zigzag [A,B,C] which means when the current rally which is wave A is complete we should see a deep pullback to the 6100-6200 area for wave B, followed by a rally to 6600. This only applies if 6380.5 is broken.