Bumpy ride ahead for UK, global equities

January was clearly a month of two halves for global equities: falling sharply in the first part and recovering noticeably in the last couple of weeks. Ultimately however, the severe damage caused from the sell-off in the first half of the month meant that it was a bad January overall. Sentiment was hit by increased concerns over the health of the global economy, most notably China, and the implications of the continued falls in the price of crude oil.

Unsurprisingly, oil was then a big catalyst for the stock market recovery as prices rebounded strongly in the second half of the month. The trigger was initially profit-taking from severely oversold levels, then speculation that key oil exporters Russia and Saudi may agree to cut their output by around 5% each. So far, nothing has been agreed upon but both countries appear keen to hold talks. The key risk therefore is that no such agreement will be reached. If so, speculators may quickly abandon their long positions that they had opened over the past couple of weeks. This will undoubtedly have negative implications for the stock markets, especially in the energy sector. But if these big oil producers agree on an output cut and more importantly stick to their promise, this would point to a much tighter oil market in 2016. So oil prices, and therefore stocks, could climb a little bit further. Ultimately however it is unlikely to have lasting impact on prices because of the fact other oil producers (e.g. Iran or the US) may simply ramp up their exports and keep the excess global supply intact.

One of the other main catalysts behind the stock market recovery was the Bank of Japan’s decision to cut interest rates into the negative last Friday. The BOJ thus brought its policy closer to the ECB’s, with the latter most recently signalling that more QE could be on the way in as early as March. Because of the growing disparity between the policies of these central banks and the Federal Reserve, the US dollar rose significantly on Friday. Clearly, the Fed is now going to be more cautious about hiking rates further, or risk making US exports unaffordable for many of its trading partners. The potential for central bank QE and interest rates to remain low and negative for longer, much longer, than previously expected, means higher-yielding stocks could benefit as a result.

That being said however, QE has had little impact on economic growth outside of the US and has only helped to inflate stock prices. Economic growth is now slowing even in the US, while in China it remains a big worry for policymakers and investors alike. The latest manufacturing PMI data from China that were released overnight clearly underscores this view. In Europe, the PMIs were also not great although the UK’s was better – not that it gave the FTSE much of support. So, unfortunately there is a risk that the global economic recovery stalls and reverses this year. Since the markets are forward-looking, that is exactly what they have been signalling recently. As such, the still-elevated stock markets could take investors for another bumpy ride in February, and possibly beyond.

Indeed, from a technical point of view, the FTSE still remains entrenched in a downward trend despite a two-week rally at the end of January. Admittedly, the rebound has created a few bullish developments including a potential false breakdown reversal pattern around 5770, and a move above strong resistance in the 6000-25 range. So, it could be that a bottom may have been established. However, it is far too early to confirm that with any degree of confidence and with the index holding below the bearish trend line and also the 200-day average, the trend remains bearish until proven wrong.

But in the short-term, for as long as this 6000-25 range holds as support the path of least resistance is likely to remain to the upside. However, from false breaks come fast moves in the opposite direction, and so if this proves to be a false break then the index could easily drop back to 5770 before deciding on its next move. An eventual break below 5770 would be a particularly bearish development.

On the upside meanwhile, another potentially strong area of resistance sits around 6150 to 6185, an area which corresponds with convergence of the bearish trend line with two Fibonacci retracement levels: (1) the 38.2% of the move down from the previous all-time high and (2) the 61.8% of the most recent downswing. So, there is a good chance the FTSE may turn lower if it tests this key area. However, a decisive break above here could see the index rally strongly towards the 200-day moving average at 6430. This moving average sits just below the next key resistance area of 6440-6490.

So, depending on the direction of the next break, we could see the FTSE make a sharp move in that direction. Conservative traders may wish to wait for the index to make its move before jumping on the bandwagon, especially if going against the underlying trend (which for now anyway is still bearish).