Asset Allocator: January 2016

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ASSET ALLOCATOR: 26th January, 2016

 

That was fun wasn’t it! Last week we saw a dramatic turnaround in investor confidence. In the first half of the week the bears were in the ascendancy with the FTSE 100 slipping to a recent low of 5637. By the end of the week the bulls had rampaged back with the benchmark UK index back above 5900.

The $64 billion question is what happens next? In some respects, the obvious answer is to look at the price of oil. As the chart below shows – taken from financial software service Sharescope – the price of oil (the thick blue line) and the FTSE 100 (the thin blue line at the top) seem to move in line with each other, although it goes without saying that the fall in the price of oil has been much more dramatic. My own instinct is to suggest that we’re nowhere near the bottom for oil prices with the next barrier at $25 and then $20 a barrel. Hopefully this adjustment in oil prices will be quick in which case we might see no more than a few more weeks of nasty equity market turbulence.

But any commentator on the markets is also forced to admit that second guessing what might happen next to the price of oil is a hopelessly forlorn task – although I would argue that on every technical measure still looks dreadfully bearish.

An alternative way of answering the question about what happens next to the FTSE 100 is to look at the recent record of equity market routs and rallies since 2010. The table below looks at a long run of rallies and routs dating from Spring 2010. In each case I have taken a recent high and then moved forward to the following low. You’ll notice that at current levels for the FTSE 100 of around 5850 we’re not that far off the levels seen in April 2010 when this table starts. 

 Month  FTSE 100 Index Level  Change from peak to low
 April 2010  5744
 July 2010  4805  +16.5%
 Feb 2011  6091  +26.7%
 Feb 2011  5598  -8.1%
 July 2011  6054  +8.1%
 Oct 2011  4944  -18.44%
 March 2012  5965  +20.65%
 June 2012  5260  -12%
 May 2013  6696  +27%
 June 2013  6029  -10%
 May 2014  6878  +14%
 Oct 2014  6195  -10%
 Nov 2014  6750  +9%
 Dec 2014  6182  -8.5%
 April 2015  7030  +13.71%
 August 2015  5898  -16.2%
 Oct 2015  6417  +8.8%
 20th January 2016  5673  -11.6%
 Average % Decline  -12.36%
 Average % Increase  +16%

I’ve also turned most of this information into a messy looking chart below – also from Sharescope – over which I have superimposed these rallies and routs.

 

The key point for me is that the most recent decline – from October 2015 through to January – of 11.6% is about what we’d expect for a recent post GFC/QE rout. The average fall for the last 9 routs has been around 12% although that includes smaller falls of 8% as well as much bigger 16% + declines (last seen in summer 2010).

The average post rout market increase by contrast has been a hefty 16%. If that were to happen after the lows of last week we’d see a near term bull market peak of 6,580 for the FTSE 100. The current 3 to 4% rebound (to around 5,900) is nowhere near the same amplitude of increase as seen in post 2010 rallies.

Unfortunately given the drum beat of bearish macro-economic news, I struggle to believe that even if we have seen the worst of the market falls, a continued rally probably won’t push up the UKs benchmark index by much more than 10%, implying a near term peak of around 6,200. But if this bullish view is right the current recovery has much, much further to run.

On balance though my guess is that we might see the barrier of 5,600 tested again for the FTSE 100 tested. Oil prices look both technically and fundamentally horrendous and there has to be a distinct possibility of another move down in the blue chip index.

My own view is that the bearish sentiment towards equities is massively overdone. As oil prices drift ever lower – and stay low – its tremendous news for the real economy outside of finance. Sooner or later this good news will show up in the earnings numbers and we might see a much stronger Q2 and Q3 for 2016. I for one will use the FTSE at 5600 as the key barrier with 5800 the earlier test. If markets slowly inch towards 5800 again I’d happily start piecemeal buying into any options based structure that leveraged returns on the upside. If the index hits 5600 or even lower, I’d be a very enthusiastic buyer of these options and structures.

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The content of Asset Allocator is provided by David Stevenson, an independent financial journalist. The views expressed in this page are those of David Stevenson only, and Societe Generale takes no responsibility for his views. The views expressed are David Stevenson's views as of the date of publication only. Neither David Stevenson nor Societe Generale accepts any liability arising from investment decisions you may make for your own account. This material is intended to give general information only and is not to be construed as investment advice. The investments mentioned may not be suitable for everybody and you should ensure that you fully understand the investment you intend to make before making an investment. Links to external websites are not operated by or affiliated with Societe Generale. While we aim to point you to useful external websites, we cannot be responsible for their content or accuracy. Societe Generale takes responsibility for the views expressed on any external websites or any liability arising from investment decisions you may make. You should seek professional advice if any of the content of this page is unclear.

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