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After the rally in the first half of October, there is a risk the FTSE 100 will turn down to resume its decline. The October high at 7565.1 remains intact, this level is close to the all time high at 7599. There is strong resistance in the area 7565-7599. Based on the Elliott wave pattern the index can still rally to the 7540-7550 in the next few days but breaking above 7565 will represent a challenge, unless the pound collapses. The FTSE is sensitive to GBP/USD and with the pair moving up in anticipation of a rate hike on Thursday, the FTSE is unlikely to make a new high. A sharp drop in GBP/USD on the other hand would boost the FTSE and in this case the UK index could rally to new high, but upside is limited because the US markets are in a topping process.
The 34-day BTI, my proprietary indicator which identifies major market turns did not become overbought. The indicator peaked at 302 and is now going down. I was expecting a move to 400 or higher which is when the odds of a major top are at the highest level. Nevertheless, there are other indicators that tell us that we are at or near a major top, like the VIX at multi-year lows, the bitcoin mania, the percentage bulls at highest level…without mentioning that stocks in the US are overvalued. I mention the bitcoin mania because when an obscure market becomes fashionable with traders and is making headlines everywhere in the media, this tends to coincide with a stock market top. When investors start looking for faster returns and they find a market that can deliver, they will create a bubble in that market. When that bubble pops, the stock market will go down fast.
A similar thing occurred in 2000 when investors turned to technology stocks to make faster returns and ignored traditional stocks that were considered too slow to move up. The tech bubble burst and in the process the stock market crashed. After the crash technology stocks were ignored and traditional stocks became popular again. I remember in 2007 before the financial crisis everybody was talking about China, China was the new place where you could make your fortune. Although there was no link between China and the financial crisis, the fact that people were looking to China for better returns was an indication the stock market was peaking. History tells us that the bitcoin mania will end in tears for many, and the stock market will crash.
Extreme optimism drives the stock market higher in the final part of the bull market which is where we are now. This is reflected in the extremely low VIX, there is no fear. Unfortunately indicators of major market tops are not timing indicators, they don’t tell us with precision when the market will peak. This condition (extreme optimism) can remain in place for months. Then one day…pop! Divergences between markets are another indication markets are not well. The divergence between the FTSE (below its all time high) and US markets (making new all-time highs) has been in place for months. I am not saying that the FTSE won’t make a new high but the odds of a new high are low.
In the context of extreme optimism and a possible bearish Elliott wave pattern, investors and traders should take some protection. The rally to 7565 could be wave C of an expanded flat [A,B,C] which is an upward corrective pattern in a downtrend. This pattern assumes that the FTSE peaked at 7599 and the decline in June was the first wave of a long term decline in five waves. If this pattern plays out the next move is the third wave down, in this event the FTSE would decline below the bottom of wave B.
Thierry Laduguie is trading strategist at www.e-yield.com
