London Index Rallies After Shoddy Week Of Trading

The interconnectedness of global markets is a boon and a bane to investors. The week began with what was dubbed Black Monday, although this spurious connection to the infamous 1987 Black Monday is anything but accurate. On that day, Wall Street plunged 22%; fast forward 28 years later, and Wall Street’s drop was around 500 points, but that comprised just 3%-4% of the Dow Jones Industrial Average. London is not immune to what happens on Wall Street, or Shanghai for that matter, and the FTSE 100 index plunged on Monday, 24 August, recovered somewhat on Tuesday, lost ground on Wednesday and finally turned the corner on Thursday, 27 August. This seesaw performance has traders licking their lips, but unsure of which direction markets are going to move.

A few pointers are in order:

• China is the proverbial elephant in the room – the bear in this case. The authorities in China have begun cracking down on financial institutions, banks and other black market operations that have facilitated massive capital flight from China. The maximum limit that individuals can withdraw per year is $50,000, but banks have been allowing much more than this.
• The Chinese economy is in trouble, as evidenced by the numbers from Beijing. Manufacturing figures are down, GDP is at a 25 year low, interest rates have been cut 50 basis points and government intervention in the stock markets has been excessive.
• China has also been selling massive quantities of foreign currency reserves to prop up the ailing CNY.
• Central banks all over the world have been assuaging investors by continuing to support the global economy with monetary easing.
• The authorities in Beijing have been ploughing hundreds of millions of dollars into blue-chip stocks, to bolster national pride ahead of the WW2 victory celebrations over Japan scheduled for September 3, 2015
• The European Central Bank intimated that the €1 trillion QE program could continue beyond September 2016, and this also allayed market fears.

The Bulls Power the FTSE 100 Index

The FTSE 100 Index Rally

The FTSE 100 index traded at a daily low of 5979.20 and rallied over 6,212.48 (+3.74%) points on the back of positive news coming out of Wall Street, China and other European markets. For starters, one of the policymakers from the Fed announced that it was unlikely that a September rate hike would take place, given that conditions were not quite right for any action to be taken in September.

This does not rule out the possibility that a rate hike will be implemented in October, perhaps even December. The words used by Mr Dudley of the New York Federal Reserve Bank indicated that the case for a rate increase was less compellingnow given current realities. However, this news spread far and wide, prompting a buyer rally on Wall Street, London and across Asia.

The London index gained well over 3.7% by the close of trade on Thursday 27th of August. By early morning, it was already trading at 6099 points (+2%), but as the day progressed the FTSE kept on rising. Mr Dudley also allayed investor concerns by saying that there was no structural weakness or fundamental weakness in the US economy, implying that the problems were largely Chinese in origin. Since the cost of borrowed money – credit – will not likely increase in the next several weeks, investors took heart from this news and immersed themselves in a buying frenzy.

How to Trade the FTSE 100 Index

I would definitely caution traders about being overly bullish about the FTSE 100, especially during highly volatile trading sessions. Global sentiment remains uncertain, and the structural weaknesses in the Chinese economy are real. With commodities prices at multi-year lows and demand tapering off, it is clear that the equities correction was overdue. Consider that the 52-week low for the FTSE 100 index is 5898.87 points and the 52-week high of 7103.98 points. That means that the index is approximately 900 points lower than its year high, and just 300 points above its year low. There is plenty of upside potential, but caution is the order of the day.

On Black Monday, the London stock exchange wiped out £74 billion – the largest single day drop in 6 years. Some of the stocks that fell on the FTSE 100 include Imperial Tobacco, Whitbread, Morrisons and Randgold Resources, however their declines were rather limited. Barely 24 hours ago, analysts were reporting that £26 billion had been erased from the all-star index. On Tuesday, 25 August, the FTSE gained to the tune of £46 billion so it is clear that we’re in a highly volatile market right now.

Buyers are looking for value stocks at these prices, but there are plenty of automatic stop losses built into the trading system to initiate massive sell-offs if further declines occur. It is abundantly clear that the FTSE 100 index is now corrected, after having lost more than 10% since its 52-week high in April 2015. Therefore I would err on the side of caution and go long on the FTSE 100, with my finger of the pulse with put options if Chinese equities head south in the coming days.