How to use moving averages to pin down the FTSE 100

In capital, local currency terms, the UK is the worst performing country among the 23 nations classified by the MSCI as ‘developed’ markets in 2018 to date.

The UK is the worst performing developed market so far in 2018

Source: Thomson Reuters Datastream. *To 13 March

Investors will have their own views as to why this might be. Domestic political uncertainty, global geopolitical concerns, more hawkish central banks, sluggish economic growth and the reliance of FTSE 100 profits and dividends upon such unpredictable sectors as banks, miners and oils are all plausible explanations for the latest attack of the jitters.

The question to address now is whether the UK’s premier stock market index gathers itself to ‘climb the wall of worry’ once more or whether it will succumb and start to ‘slide down the slope of hope.’

In the long term, aggregate corporate profits, cash flow and dividends will dictate the benchmark’s fate and this column would always prefer to focus on the fundamentals above all else.

The good news is that forecasts for FTSE 100 profits and dividends in 2018 and 2019 still call for healthy increases on all counts, based on our latest analysis of analysts’ consensus forecasts for each individual member.

Analysts still expect solid earnings and dividend growth from the FTSE 100 in 2018 and 2019

Source: Digital Look, company accounts, consensus analysts’ forecasts

The bad news is that the forecasts have stopped going up for 2018, to leave the market rather becalmed and looking for fresh direction.

FTSE 100 profit and dividend forecasts have stopped rising

Source: Digital Look, company accounts, consensus analysts’ forecasts

One way to try and judge whether the FTSE 100 is capable of making fresh gains or is primed for a further fall, at least in the near term, is to look at technical indicators, particularly market breadth and the number of index constituents that are rising or falling.

For the moment, the number of gainers outranks the number of losers to suggest the FTSE 100 is capable of holding its ground before a fresh push higher but this picture could change quickly and it is one which this column shall continue to monitor.

Get moving

While this column has little ultimate faith in technical analysis and the study of charts, a little digging into what is making the stock market tick can be of use.

One way to do this is to look at market breadth and how many stocks are rising or falling at a given time, especially with regard to their moving averages (MAs).

Moving averages can help to cut through the noise created by day-to-day price movements and look at a trend. Technical analysts can look at 10, 20, 50 or 200-day moving averages. A simple moving average is calculated by taking the average closing price over your preferred period, say 50 days, to create a new average for each day. The results are then plotted as a line on a chart and the trend assessed.

Chartists will argue that moving averages can act as support to a price or resistance and it is often moves through support (to suggest further downside) or resistance (to imply there could be further upside) that get them most excited.

The overall picture for the FTSE 100 currently looks pretty mixed. The index has gone down through its 10- and 50-day moving averages, with the slowly rising 200-day indicator perhaps primed to offer support somewhere near 7,000.

FTSE 100 may look toward its 200-day moving average for support

Source: Bloomberg data

Feel the width

Another way to use moving averages and technical indicators is to look at the individual stocks which comprise an index – after all, it is their movements which ultimately drive the headline indicator up or down.

This is a good way of gauging market breadth and depth. If the index is rising but only a select band of constituents are gaining then breadth is narrow and the advance is not to be trusted.

Equally, a broad-based advance would suggest an index is in good health and potentially capable of broader gains, all else being equal.

This final graphic looks at the number of FTSE 100 stocks that are currently trading above their 50- and 200-day moving averages. Again, the more the merrier, although at the time of writing just 40 constituents are trading above the 50-day indicator and 54 above the 200-day one.

Breadth of FTSE 100 price action suggests index is trying to find a floor

Source: Bloomberg data

They are both improvements on the year-low numbers of 12 and 36 reached in mid-February but well below the highs of 81 and 69 respectively reached in January.

This technical indicator suggests the index is trying to find a floor and gather itself but that investors have perhaps yet to be fully convinced that profit and dividend growth momentum are sufficient to provide the necessary impetus even if the UK’s dividend yield, in absolute terms and also relative to bonds, remains a key source of potential support.

Russ Mould, AJ Bell Investment Director