Interactive Investor

Chart of the week: is the FTSE 100 on a cliff edge?

4th October 2021 11:55

John Burford from interactive investor

After a summer spent moving largely sideways, our charts expert assesses the possibility of a dramatic breakout soon.

As you know, I have been taking a bearish stance against the FTSE 100 for some time, believing it was poised for a significant decline. But my patience has been sorely tested as it has traded in a narrow range from 6,800 to 7,200 since April. But now I see signs of a breakout soon.

Here is the updated weekly chart I have been posting:

Past performance is no guide to future performance

While the US indexes have been making new all-time highs until very recently, the FTSE has lagged badly in comparison – largely because the US has most of the all-conquering Tech Titans on the western side of the planet that have been subject to the most intense speculation. The FTSE’s record high was made in 2018 and, so far, that level has not been exceeded.

For a student of Elliott waves, this picture is pretty clear – we are now poised to move lower in a strong wave 3 of 3 decline with high confidence. If so, then this decline will be very powerful as third waves are usually the longest and strongest on any chart.

The market has been battling to move above the Fib 76% resistance around 7,200 for some time, and even recent sterling weakness has failed to do the trick.

Here is a close-up of recent action:

Past performance is no guide to future performance

That is a lengthy consolidation phase and a move down out of it would very likely be dramatic – and help confirm the start of a major third wave. More confirmation would come as and when the 6,800 support level is breached.

There is a clear link between social mood and stock valuations as measured on broad indexes such as the FTSE 100. When we are generally feeling positive about the future, we tend to buy shares – and vice versa (that applies equally to the managers who run the large institutions).

This is a chart of the well-known University of Michigan consumer sentiment surveys (the UK would likely closely follow these patterns):

This does not paint a positive picture for the future

It is clear to most that the public mood is now turning sour following the sense of relief that the overall effects of the pandemic are behind us. But take a look at this very revealing chart that lays out the extreme herding among investors that has built up in recent months:

Past performance is no guide to future performance

It shows the global equity money inflows annually to August. This year's spike will be a lot higher – and off the scale – when the final year-end 2021 data is compiled.

Many would view this stampede into equities this year as a bullish sign of supreme confidence. But it is far from it. It has come at the end of a multi-decade bull market that has pushed up valuations to the stratosphere. 

These investors have been buying with both hands at the top – a very common effect of a lengthy roaring bull market. I would say we have a buying climax this year. Successful investors buy at the lows and sell at the tops, not vice versa.

Only an unlikely push above the 7,200 area would send me back to the drawing board.

John Burford is the author of the definitive text on his trading method, Tramline Trading. He is also a freelance contributor and not a direct employee of interactive investor.

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