For an answer we can, once again, compare the FTSE 100 to some historical precedents. On the broad national economic front there are increasing warnings as to the severity of the ‘medicine’ that the next UK government is going to have to administer to the economy and it is sensible to consider and conject what the effect might be on the stock market.
The closest historical comparison to the current situation is the collapse and subsequent recovery of the FT 30 index back in the 1970’s when there was a similar dire national economic scene and deep recession.
Let us look at the (worrying) similarities that existed then and now. Here is the 1970’s picture -
(click on charts to enlarge).
And here is the current picture -
The first thing that strikes one is the similarity in the pattern of the stock market despite the gap of 40 years. The second thing of note is that the collapse in 2007-09 (at -49%) has not been anything like as serious as the collapse in 1972-74 (at -73%) but then the recovery rally has not reached anything like the same proportion either; +62% so far in 2009-2010 compared with + 153% for the first tranche recovery in 1975.
The important thing though is to ask if the pattern of the FTSE 100 over the last few years, being so similar to its predecessor in the 1970’s , is likely to continue to follow a similar path. This is important because, as can be seen from the FT 30 chart, the recovery rally finally ran out of steam after increasing by +192% from the Jan.’75 low (at 144). The in-ratio equivalent for the FTSE 100 now would be +78%. This suggests that, if the pattern continues to mirror the 1970’s then the FTSE 100 could be set up to reach the 6160 level ( + 78% from the 3460 March’09 low) before any serious correction occurs. In 1976 the correction was a big one and took the index back down to the 50% Retracement level of the recovery rally and this would indicate a correction for the FTSE 100 down to the 4810 level; being the 50% Retracement of the 2009-2010 recovery rally IF the index does reach as high as 6160.
But there is a lot of doubt that the FTSE 100 can make it that high. It is some 520 points, 9%, higher than today’s close ( at 5640) and there is a deal of technical resistance (at the 5770 and 5930 levels) that would have to be overcome for this to be possible. In addition, there is the message being broadcast to us by our proprietary ‘Momentum Indicator’ (‘MI’). This indicator has a good history of identifying potential and actual market tops (although sometimes many weeks ahead of the actual event). It is indicating to us now a potential for a new market top. Whether this will be but a short lived correction or ‘the big one’ we cannot yet say although the continuation of the pattern similarities between now and the 70’s does suggest that it would pay us all to be aware of the potential for a sharp correction
Below is a chart of the FTSE 100 and, below it, the Momentum Indicator -
To support a rising market and one that is likely to keep rising we would expect the MI to follow a similarly upwards moving path to the index itself. But here, you will note, the FTSE 100 has been rising quite steeply whilst the MI has been meandering along sideways. Not a healthy sign.
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