Where Now for the FTSE?
The third quarter has not started well for stock markets; the FTSE 100 has so far been unable to break the losing streak that saw it drop below 5000 towards the end of the second quarter.
The UK index shed over 150 points on 29 June, a fall of more than 3%. The final day of the second quarter, 30 June, was more or less flat, as a bad day for cyclical shares was countered by upbeat trading on defensive stocks. Then on 1 July, as the third quarter got underway, the FTSE was compounding its second-quarter losses, down a further 1.2% or 60 points to 4856.
A similar pattern has been seen on Wall Street, while Asian equities have also come under sustained selling pressure over the past days.
But what is causing this broad-based weakness for stock indices? And is there any light at the end of the tunnel for investors, or are we back in a bear market that is going to be dominated by short selling?
Manufacturing slowdown in Asia
News that the rate of production in Chinese factories slowed during June was a blow for sentiment. The damage was compounded by slower expansion across the rest of the region, including in Japan, India, Taiwan and South Korea. [1]
The importance of Asia’s role in the economic recovery should not be underestimated. The FTSE’s mining sector – one of the largest sectors in the index – is made up of a number of international heavy-hitters, including BHP Billiton, Rio Tinto and Xstrata, all of whom rely on China’s appetite for natural resources. A drop in demand from China tends to mean a drop in mining share prices.
However, Asia’s progress is also important for broader sentiment. Both as a trading partner for economies struggling back to growth and as a bellwether for global sentiment, China has been at the forefront of recovery, partly due to the fact that its more tightly-regulated financial sector avoided some of the pain felt by the UK, US and Europe.
On the other hand, growth has not stopped, it has merely slowed – a fact that more bullish investors will be keen to point out. Nevertheless, a slowdown in China (and a subsequent slowdown across Asia) is likely to hit indices in the UK and US.
Eurozone in crisis, again
Influential credit rating agency Moody’s pushed the EU sovereign debt crisis back to the top of the agenda this week by warning that it was reviewing Spain’s AAA rating. While the news took its toll primarily on the euro, the knock-on effect for sentiment contributed to the downturn for equities.
Nor does the debt issue look to be put to bed anytime soon. While the countries that make up the rather unkind ‘PIGS’ acronym, namely Portugal, Italy, Greece and Spain (and especially their financial sectors) have long been in focus, questions are now being asked of more ostensibly robust economies. For instance, the German government is preparing to inject liquidity into some of the country’s banks following the results of stress tests, some of which are expected to expose a worryingly thin layer of capital reserve.
The flipside is that the ECB has reported a relatively low take-up of funding that was put on the table to replace €442 billion of 12-month loans that expire this week. However, while this hints at a healthier banking system in Europe than many analysts fear, the news was not in itself enough to prevent further slides for equities. Furthermore, there are still concerns over those institutions that did use the ECB’s latest loan facility.
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Updated: 01/07/10
Source: [1] The Financial Times (1 July 2010)
The above comments do not constitute investment advice and IG Index accepts no responsibility for any use that may be made of them.