FTSE 100: The Next Correction Will Be Painful

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At today’s FOMC meeting the committee will have to make some big decisions. One main topic for policymaker’s consideration is whether or not to begin the process of tapering QE, and if they decide to taper, when to start. The timing of the tapering could have a massive impact on the stock market which has gone up too far too fast in the last five weeks.

The stock market is driven by an army of stimulus addicts, mention the word stimulus and stocks go up. Back in May we knew that the Fed was going to slow down the pace of bond purchases with a view to ceasing these purchases sometime in 2014. The stock market fell sharply in June but today it would appear that investors have already forgotten what tapering means. However, eventually it will happen and at the earliest in September.

For now investors are happy to keep buying because they don’t have the choice. Too many money managers have underperformed as a result of being cautious in the past when market uncertainty was high. When the economy is weak, fund managers will err on the side of caution and position defensively, however in the current climate bad news is good news which translates into more stimuli, so investors are left with no choice but to go long to keep up with the market trend.

I believe it won’t be long before we see another sharp sell-off similar to the one we saw during May and June.  The FTSE 100 could decline below 6000 within months. The reason is because the Fed is trapped -the economy remains weak after four continuous years of financial engineering and despite all the money that has been thrown, the system is showing no signs of improvement.

The following recently reported economic numbers have been on average below estimates:

29/07/13    US pending home sales        better
24/07/13    China PMI manufacturing    worse
US new home sales        better
22/07/13    US existing home sales        worse
18/07/13    US jobless claims        better
17/07/13    US housing starts         worse
15/07/13    US retail sales            worse
11/07/13    US jobless claims        worse
10/07/13    China trade balance        worse
09/07/13    UK industrial production    worse
08/07/13    Germany industrial production    worse

What is clear is that the bond buying program can continue indefinitely but what we don’t yet know is whether this is good or bad for the economy. Judging by the way commodity markets, in particular gold, are behaving something is not working as it should. There is still no evidence that QE can revive an ailing economy, yet on the other hand tapering QE would be catastrophic for stock markets and the economy at this point down the line. You will recall that when the crisis started in 2007 central banks lowered interest rates to boost the stock market and the economy. Well, rates have been near zero for the past four years and we have yet to see an economic recovery let alone a booming economy!
As Bernanke has said: “If we were to tighten policy, the economy would tank”.

Thierry Laduguie is Market Strategist at www.bettertrader.co.uk

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