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Five ways to take the markets’ temperature
The FTSE 100 continues to paddle gently sideways – it is summer after all. The UK’s benchmark index has gone nowhere since May and still stands around 10% below its May 2018 peak of 7,779.
Yet the vagaries of the FTSE 100 – which has exposure to sectors that are unpredictable (miners and oils), indigestible (banks) and stodgy (drinks, tobacco, food retailers) – should not cloud the good news elsewhere.
The FTSE 250 and FTSE Small Cap indices trade at all-time highs, the FTSE AIM All-Share is very close and the FTSE Fledgling is not far away from its loftiest mark since 2017.
Farther afield, the America’s S&P 500 and Nasdaq Composite and Europe’s Stoxx 600 also stand at fresh all-time peaks.
So rather than focus on the rather misbegotten FTSE 100, investors should look at the wider picture. They need to ask whether the good news can keep rolling or whether something is about to sneak up on them and derail global equities’ momentum.
Regular readers will know this column has five tried-and-trusted tests and intriguingly all of them look inconclusive right now.
THE FIVE TESTS
1. Dr Copper: The industrial metal has this nickname because its malleability, ductility and use in everything from cars to housing to domestic appliances make it a great barometer for global economic health.
Copper’s stunning surge over the past year looks to be fizzling out a little, as the metal is 10% off its highs. A fresh advance in copper would help to reaffirm investors’ faith that the inflation/reflation trade is the right one, while further weakness would raise fears of an economic slowdown and even the worst of all worlds, stagflation.
2. Small caps: Market minnows are an excellent indicator of risk appetite. They tend to outperform when investors are bullish and fall faster than the broader market when they are bearish. The UK’s FTSE Small Cap index may be setting new highs, but America’s Russell 2000 is not.
3. The transportation indices: The old theory goes that if the transport stocks are not performing, industrials cannot do so either. If nothing is being shipped, nothing is being sold.
It is therefore of some concern to see America’s Dow Jones Transport index brushing up against the buffers. Bullish investors will feel happier if that index can start moving higher again.
4. Junk bonds: High-yield bonds lie at the riskier end of the fixed-income spectrum as their more pejorative name of junk bonds would suggest.
The issuers have creaky balance sheets, volatile cash flows or both, and they need to pay a higher coupon to attract buyers of the bonds.
They can trade a bit like equity, such is their risk profile, so bulls of stock markets will be pleased to see the US-listed iShares iBoxx High Yield Corporate Bond ETF performing well.
This may be down to the ongoing reach for yield in a low-rates world, but the tracker is trading near six-year highs and is not close to going below the $80 level, a move which proved to be a harbinger of wider market volatility in 2008, 2015 and 2020.
5. Volatility: This can be the friend of the investor as it can provide chances to sell stock expensively or buy it cheaply. Yet history shows that stock indices progress best when they make a series of modest gains and tend to fare less well when trading is choppy and there are big swings up and down.
America’s VIX, the so-called ‘fear index’, stands well below its lifetime average of 19, which points to bullish sentiment.
Equally, the reading is creeping up, just as copper and the transports are creeping down.
This may just be a case of summertime lassitude, but it could be a sign the bull equity market is about to face its latest test, be it inflation, the pandemic, central bank policy or (more likely) an exogenous event.