The FTSE has lost some steam since Monday, over fear that the domestic equity market has gotten ahead of itself.
The blue-chip index ended eight straight days of gains on Monday after reports from the British Chambers of Commerce (BCC) and the Confederation of British Industry (CBI) urged the UK government to come up with a ‘convincing’ plan for cutting the country’s bloated deficit - this may have left investors feeling as though Britain could potentially become the next Greece.
The BCC also cut its UK growth forecasts for next year to 2.1% from 2.3%, adding that long-term domestic growth prospects remain weak. ‘The need to significantly cut the UK’s huge budget deficit, strengthen the enfeebled banks, and reduce personal debt will inevitably limit growth in the next few years,’ said BCC chief economist David Kern.
Exacerbating the situation was a wider-than-expected UK deficit for February, a slowdown in UK house price growth and bleak reports from Moody’s Investors Service and Fitch Ratings.
On Tuesday, the Office for National Statistics revealed that the UK goods trade deficit with the rest of the world unexpectedly widened to £7.987 billion in January, following a 6.9% drop in exports – this is the widest deficit since August 2008 and substantially larger than the £7 billion gap shown in a Reuters survey.
Separately, the Royal Institute of Chartered Surveyors (RICS) explained that the supply of available homes for sale is beginning to outstrip fresh demand and that this imbalance is likely to erode the pace of house price growth going forward.
Meanwhile, the domestic banking sector was pressured by a report from Moody’s, which said British banks may have their financial-strength rating slashed, as the UK government withdraws support to bring down its budget deficit. Meanwhile, Fitch Ratings warned that Britain’s sovereign credit profile has deteriorated, but that it is still within tolerance of its top-notch rating for the time being.
So where is the FTSE heading next?
The trend over the last year has been extremely bullish, which is likely to encourage investors to take advantage of any weakness, and buy on the dips in the short term. Personally, I feel that there is a lack of catalysts at this stage and I believe that upside potential is limited.
From a technical perspective, the 14-day relative strength index for the FTSE 100 is showing that the domestic equity market is trading at overbought levels, while the moving average convergence divergence indicator is signalling a change in the trend at this juncture.
On a fundamental level, however, the FTSE 100 is trading at a PE ratio of 12.27x (based on Tuesday’s close), which is cheaper than the DAX, CAC 40, S&P 500 and Dow Jones Industrial Average but slightly above its historical average of 11.5x and median of 11.81x.
Anthony Grech is Research Analyst for IG Index, the world's largest and longest running spread betting company.
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