FTSE volatility has traders on edge, so how can you safeguard your investments?
The FTSE 100 is the UK’s premier stock market index featuring 100 of the top cap-weighted companies on the LSE. For the week ending Friday September 25 the FTSE 100 closed at 6109.01 for a gain of 147.52 points on the day, and despite choppy trading this week closed Wednesday at 6061.61.
Such figures mask an otherwise sharp bear trend, however, as the UK blue-chip index has fallen 14.7% since hitting an all-time high of 7122.74 in April. The FTSE’s 52-week trading range is between 5768.22 and 7122.74, the 1-year return is -4.46%, and for the year to date (as at September 25) the index has a -6.96% return. Based on these figures, it is clear the FTSE is trading near the 52-week low range, largely on the back of weak global demand as a result of deeply concerning economic data from China.
Weak factory data from China (six-year lows) has sparked concerns that the pace of Chinese economic growth is slowing and that the purported growth rate of 7% will likely not come to pass in 2015. In fact, many analysts are expecting that Chinese GDP for the year will be in the 5% to 6% range. There are several other factors weighing on the FTSE, including Janet Yellen’s recent speech to the University of Massachusetts on Thursday 24 September where she intimated that a rate hike before the end of the year is likely. The Bank of England might be more keen to move in line with a Fed decision to raise rates rather than go it alone.
Global financial markets are experiencing unusually high volatility at this time. This is largely the result of residual anxiety related to the impending Fed rate hike, weak economic growth in China, plunging commodities prices, and the fate of emerging markets. All of these factors are intertwined, and many of them depend on the Fed decision and China weakness. Despite the September 16-17 FOMC decision not to hike rates, market concern has not dissipated as participants are looking straight towards the next Fed policy meeting. Should the Fed decide to hike rates, capital flight from emerging market economies like Brazil, Russia, India, China and South Africa will accelerate.
Emerging markets weigh heavily on the FTSE
Brazil is already experiencing a crisis of epidemic proportions, with President Rousseff facing impeachment proceedings. Brazil leads the emerging market world, and analysts will be looking closely at what happens in Brazil regarding the leadership crisis, corruption and the inflation rate.
Emerging market economies were able to rack up substantial foreign currency holdings during the boom years before the period of quantitative easing dried up. When the Fed ended QE, capital flight from emerging market economies accelerated and divestments took place. Additionally, EM currencies reversed direction and depreciated. That trend continues today with currencies like the Brazilian real, South African rand, Turkish lira, Venezuelan bolívar, Russian ruble, Malaysian ringgit and Indian rupee taking a pummelling.
The fate of EM markets and currencies impacts directly on the FTSE 100. For starters, mining stocks comprise a sizeable component of the index. Companies like BHP Billiton, Anglo American and Rio Tinto are some of the biggest on the index and their performance has been hurting as a result of weak demand from China. Since these companies are largely vested in emerging market countries, weak Chinese demand leads to a decreased bottom line for these mining companies.
Over the years blue-chip companies have invested heavily in emerging markets, but now the chickens have come home to roost. Some of the countries that the UK corporate world has invested heavily in include Turkey, Brazil, Indonesia, Russia, South Africa, India and China, and all of these countries’ mining sectors have performed poorly as a result of the Chinese weakness.
Commodity-related stocks drag FTSE into the red
As you might expect, 50% of the top 10 worst-performing shares in the FTSE 100 are mining firms. Companies like Glencore, Rio Tinto, BHP Billiton and others have taken marked falls, dragging the FTSE lower. Chinese weakness is once again to blame for plunging commodity prices and poor performance from mining-related companies. Energy prices for oil and natural gas have also plunged, with WTI crude and Brent crude trading lower.
The FTSE’s key support level of 6000 was breached in September and this was largely the result of commodity-related stocks taking a beating. Market anxiety remains high and the long-term prospects for other major companies like Volkswagen are looking bleak. Already VW has lost approximately 33%, with billions of dollars erased from the company’s market capitalisation.
The ADP (Asian Development Bank) cut its growth forecast for China to 6.8% for 2015, down from 7.2%. All companies involved in commodities importing/exporting that have direct ties to the FTSE 100 have taken a hammering. And this has impacted on many developed countries too, including Australia and Canada, which are now facing sharp contractions in economic performance. Copper is 18% down on its high for 2015, with companies already cutting copper production and laying off workers around the world. Much the same is true for coal which is now 26% off its trading price at the beginning of the year.
Can the FTSE recover given the global turmoil?
The fundamental strength of the UK economy has many analysts convinced that the UK can withstand these short-term global pressures. As a case in point, the Smiths Group is one of the best performers in the FTSE 100 index. Smiths Group shares are currently trading at 1008p (Thursday midday) and, while this has dropped from last Wednesday when it was trading at 1129p, it remains a solid performer on the index.
Solid performers aside, however, we must remember that for the year the FTSE 100 remains 6.96% down (to the end of last week). Any progress now is simply catching up lost ground. Other hard-hit companies on the FTSE include Johnson Matthey, as a result of the VW diesel auto emissions scandal in the US.
So with setbacks seemingly around every corner, how can the FTSE recover? One factor that should help is the rising oil price, and this should at least help the blue-chip index to stay above the critical 6000 support level in the near term.
What can traders do to protect against volatility?
There are several things traders can do to safeguard their investment portfolios. The most important of these is not to panic. Commodity prices are going to fluctuate as long as China’s weakness persists, but this also raises the possibility of much better value in energy stocks, mining stocks and other commodity-related stocks.
Short-term put options on mining and energy stocks are a good idea and they should be hedged with long-term call options on the same underlying assets. Buying cheaply is a great idea, now that market sentiment is bearish. However we haven’t quite bottomed out in the mining and energy sectors yet, so caution remains the order of the day.
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