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Those stocks were vulnerable and remain so: FTSE

17 January 2008

We make no apology for concentrating on stocks again – they remain the focus and catalyst for much of what is happening elsewhere ... Last week we featured the S&P and the DAX, saying: ‘these stocks look vulnerable’.

They are both a lot lower now, and we don’t think that’s the end of it

Look at the FTSE…

Weekly Chart:

The FTSE is looking very weak.

The 6147 level has been very important since the beginning of 2005 and it has been smashed.

Moreover, the shape of the Top, though not perfect, has many of the characteristics of a bear Head and Shoulders Reversal – if the Neckline is drawn as shown.

The minimum target? 5400 at least.

Now look closer.

This is exciting for the bears.

The market is closing beneath the third crucial pivot of 5903.

A second close beneath there would confirm the breakdown.

(Once beneath that level it will act as a ratchet and repel all rallies....)

Volumes are high. The market touched the pivot yesterday and bounced. It tried to bounce again today but sold off hard and closed lower.

It’s still very weak.

The Macro Trader’s view:
Over the last week or so, the FTSE has probably been the most bearish of the three stock markets that we cover, as forecasters continue to predict a sharp UK economic slowdown led by a serious correction in the UK housing market.

This will lead to lower short-term interest rates, but the current uncertainties surrounding the economy and the timing of the MPC’s response are combining to drive the FTSE down as well

Traders are naturally worried that the housing market correction has the potential to cause a recession, but in a sense, the risks are the other way around.

The UK housing market is expected to correct not just because property values have become over-stretched, but for two clear reasons:
1. Lenders are expected to tighten their lending terms as they try to recover from losses caused by the credit crunch which has afflicted mainly developed western markets, and
2. A large number of fixed rate mortgages, taken when policy was much lower are set to mature early this year and the resultant hike in mortgage repayments is expected to hit demand generally as well as cool the housing market.

As general demand cools, unemployment is at likely to rise and this, together with higher mortgage costs, will be the route to the housing market correction and a general economic slowdown.

This would strengthen the case for lower rates, but because the Pound has come under selling pressure against both the Euro and the Dollar, analysts are now concerned that the MPC may not be able to ease by as much as previously expected, which they think would be considered a policy mistake.

(We do not accept that theory. If house price inflation turns negative and repossessions rise, it will be beneficial if the value of the Pound falls. Inflation shouldn’t be feared as retailers and other business will be forced to discount and accept smaller profit margins as they try to supply shrinking demand).

So the FTSE is bearish because the economic outlook is negative, but that bearishness is compounded by fears the Central Bank will not do enough as needed with interest rate cuts.

In fact, we judge they will cut rates; the MPC will act decisively once the true measure of the slowdown is apparent, and they have already alluded to this in their November quarterly inflation report.

In the meantime however, the uncertainty about economic policy is driving FTSE down, and the ending of that uncertainty will not support the FTSE as the reality of economic weakness will drive it on down in what is now clearly a medium term bear market.

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Mark Sturdy
John Lewis
Seven Days Ahead

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