Once again we saw another drop in crude oil and the FTSE 100 followed lower. Historically there is no correlation between oil and stocks but from time to time the FTSE and oil move in the same direction. Bearish sentiment was the key driver yesterday following disappointing results from BP. At one point the stock was down 8%, this is one of the largest companies on the LSE, a drop of that magnitude will drag the FTSE lower.
It’s difficult to predict what will happen to the oil price in the short term. Any sort of OPEC deal to cut back on production is expected and that is why oil rallied last week. But in the absence of fresh news hopes are fading and oil is going down again. This morning’s better than expected Chinese caixin services PMI is good news for stocks, this should also help oil rally. Yet the FTSE is trading lower in pre-open following last night slump on Wall Street.
Yesterday’s sharp decline indicates that the rally is over, I don’t expect the FTSE to return to 6115 which is Monday’s high. I was expecting a higher level because the pattern inside wave ii (circle) did not appear to be complete. Now we can say the pattern is complete but not textbook. The first part of the rally looks impulsive [wave (w)], the second part [wave (y)] looks like a double zigzag. Wave ii (circle) retraced more than 62% of wave i (circle) and the resistance line at 6125 remains intact. There is a good chance wave ii (circle) is complete. Yesterday’s decline is the start of wave iii (circle).
While January was a negative month for equity markets it was undoubtedly a month of two halves, particularly for the FTSE100 which saw a particularly strong rebound on the back of a recovery in commodity prices, as Brent crude rebounded over 25% from its lows.
Some of the recovery was also helped by a surprise cut in interest rates by the Bank of Japan into negative territory, putting it into the company of the European Central Bank and the Swiss National Bank, whose headline rates are also in negative territory, in an attempt to stimulate prices in a world of falling commodity prices, and slowing economic growth.
The biggest concern now is likely to be the likely reaction of Chinese policymakers given recent market reaction to some of their policy responses, given that not everyone can have a weaker currency.
At the beginning of last month Chinese authorities allowed the yuan to weaken sharply across the board, which in turn helped trigger the turmoil that we saw for most of the past few weeks.
This raised concerns that the Chinese economy might be in worse shape than Chinese authorities were letting on. Since then the yuan has seen most of those losses disappear, and while the most recent Chinese economic data hasn’t been particularly disappointing the fact remains that Chinese authorities are likely to push back against both the ECB and the Bank of Japan, given that over the last two years the yuan has appreciated over 13% against the euro and 8% against the Japanese yen.
As we start February the focus is likely to remain on concerns about a potential slowing down in the latest economic data, given the recent dovish noises coming out of not only the usual suspects of the ECB and the BOJ but also by the latest rather cautious assessment of the US economy as highlighted by the latest Fed statement.
We start with the latest manufacturing PMI numbers from China, Europe, the UK and the US in what is likely to set us up for either a continuation of last week’s strong rebound or a return to the widespread concern that the recent falls in stock market are symptomatic of wider concerns about economic stability.
Today we see a rally in pre-open after the Bank of Japan cut interest rates to negative, a move that should boost consumption in Japan. When interest rates are negative people have to pay the bank to keep money on their account. The idea is that this will encourage people to spend. Japan is concerned by the lack of inflation. Yesterday's GDP number in the UK was in line with expectations (0.5% QoQ) but in the US durable goods orders fell sharply in December and pending home sales were weaker than expected. Not surprising the Fed is concerned by slow growth. Yet investors are addicted to stimulus, mention the word stimulus and the market rallies. As I said before these rallies don't last, they provide opportunities to go short from higher levels.
Oil is trading at 34, given that the FTSE is currently influenced by oil it makes sense to see the index back to 6000 this morning. But the main trend is down, in the next few weeks the index will be lower. The question right now is will the decline resume now or later? When a market has been battered and the 34-day BTI is oversold there is always a risk the counter trend bounce will last longer than expected. The bounce started on 21 January, or eight days ago. When the 34-day BTI is oversold the rally will last two or three weeks. Unless we are in the situation I discussed yesterday where the index will make a new low then a multi-week rally will start.
There was no surprise in last night’s decision to hold rates by the Federal Reserve, however there appears to be some contrasting reactions to the statement that accompanied the decision.
While crude oil continued to push higher as the US dollar weakened somewhat the accompanying stock market reaction was one of disappointment and a sharp move lower as equity markets decoupled from the oil price.
As with anything where markets are concerned investors appear to have reacted more to what was removed from the statement than to what was actually in it, and interpretations varied on what the minutes were telling the markets, depending on who was asked.
Maybe that was the intention but what doesn’t seem in any doubt is the Fed is less sure of the economic environment than it was a month ago and therefore that should be interpreted as dovish, as no self-respecting central banker hikes rates in the face of uncertainty.
There is no doubt that the economic outlook has become a little bit gloomier since December so a slightly more cautious statement was to be expected, and that’s precisely what we got. There was an acknowledgement that growth had slowed towards the end of last year, a fact that is likely to be confirmed on Friday, with the latest Q4 GDP number.
This shouldn’t be a surprise and suggests that last night’s initial stock market sell-off could well be an over-reaction, or maybe a reaction to the possibility that the Fed wasn’t dovish enough?
The other main differences in the statement came with the removal of a line about policymakers being reasonably confident that inflation will rise to 2% in the medium term, as well as a line about economic risks being balanced, which would appear to be an acknowledgment of recent falls in oil prices and the deterioration in the economic outlook.
Last week stock market sell off came amid concerns the stock market slide together with the slowdown in China will cause more capital outflows. Faced with a falling stock market and growing pessimism about the economy, investors are moving money out of China and into countries with better returns. This is putting pressure on the Yuan. The Yuan will continue to fall and this process will cause an even greater number of people to move money out of China. It's like a vicious circle with no end in sight. The risk is a collapse in the Yuan. This would dent earnings at UK and US exporters.
Yet yesterday and despite a 6% slide in Chinese stocks, The FTSE 100 and the S&P 500 closed higher. It seems investors were focusing on a different matter or perhaps they are no longer concerned by what is going on in China. They should be concerned, Apple's sales are slowing in line with the slowdown in China. The company said that the iPhone would see its first ever decline in sales in the March quarter.
Investors are focusing on the Fed, they hope the Fed will leave rates unchanged tonight. The FOMC statement due at 7pm will shed more light on the Fed's intentions. It's impossible to predict how the market will react to the FOMC statement but investors could be disappointed if the Fed starts thinking about lowering interest rates. This would create panic among those who believe in the economic recovery. A no change would be bullish. The interest rate rise in December was seen as positive for stocks, it showed the Fed's confidence in the US economy. If the situation in China deteriorates, the Fed will have no option but to lower interest rates. This would be a u-turn and would greatly damage the Fed's credibility. The stock market would sell off as investors would no longer trust the Fed.
Meanwhile the market is rallying on technical factors and on the recovering price of oil. An Elliott wave pattern was complete at last week's low, this move is wave i (circle). In a bear market declines are in five waves, here we have multiple subdivisions which means the decline is far from over. Wave (3) should be in five waves [1,2,3,4,5] and wave 3 should be in five waves [i,ii,iii,iv,v (circle)]. An indicator measuring extreme in sentiment, the 34-day BTI, is oversold. This suggests the FTSE is near the start of a multi-week rally. This rally may have started on January 20th after the FTSE touched 5640, in which case the current rally has further to go. This rally is wave ii (circle), therefore the bear market will resume from an area above 6000.
The oil market continues to take no prisoners as no sooner had we seen a sharp move above $30 on Friday, than we saw a similarly sharp move lower yesterday as nearly all of Friday’s gains were wiped out, dropping back below the $30 a barrel mark in the process, as the old concerns of oversupply and financial solvency of suppliers once again reasserted themselves, as producers continued to pump at record rates.
Far from being the exception, these +5% moves in a day are rapidly becoming the norm, and while they did translate into some sharp declines in US equity markets overnight the effect on European markets, while still negative hasn’t been nearly as sharp, though we still seem set to open lower this morning.
With last week’s ECB meeting still relatively fresh in the memory ECB President Mario Draghi reinforced his message from last week’s press conference by insisting that the ECB’s credibility was at stake if it didn’t take further steps to try and meet its inflation mandate. Given the December disappointment the ECB President is trying to convince investors that the central bank will be able to act if needed, and while the euro did weaken initially it hasn’t been able to sustain much of a move below 1.08 against the US dollar.
While Mr Draghi’s claim that “if a central bank sets an objective, it just can’t move the goalposts if it misses it” is laudable it also doesn’t bear up to serious scrutiny given how often central bankers around the world have done just that, with the Bank of England a serial offender, over the last few years.
Last night Bank of England MPC member Kristin Forbes outlined her belief that the recent falls in oil prices allowed the MPC more time to evaluate whether the recent falls in unemployment will eventually lead to a pickup in wage growth, following on from Martin Weale’s comments last week.
Today Bank of England governor Mark Carney can expect some tough questioning from MP’s on the Treasury Select Committee about his continued shifting of position on the UK economy and the timing of when interest rates might rise. As recently as August last year he was hinting that interest rates could be set to rise in the coming months only to revise that position at the beginning of this year.
The Federal Reserve also begins its latest two day meeting today with the problem of what to do with the continued resilience of the US dollar after last month’s long anticipated rate increase, served to push the US dollar back towards its recent highs.