Regular readers may recall that I opened a “down bet” on the FTSE 100 index about 10 days ago.
Making short-term bets on FTSE 100 prospects is not something I enjoy because I am not very good at it. Spread betting executives privately admit that I am not the only one. Index trading is extremely profitable for them because most customers lose money.
I made my recent bet because of a strong belief that the stock market was due for a sell-off. The index has slipped about 50 points since I opened the bet, so I am currently in profit. Given my poor index trading record, my emotions are screaming for me to close the bet and bank the profit. On the other hand, all of the factors originally causing me to bet on a dip are still in place.
Recall that shares have advanced very sharply in the last six months. History repeatedly shows that rallies rarely make extended one-way moves. There are always exceptions to the rule, of course, but the stock market is certainly ripe for a healthy correction.
A second concern is linked to the calendar. Even during bull markets, big gains in the run-up to September are typically associated with September price drops.
Recent intraday price swings also support my view. Last Tuesday was a good example. The Footsie was down about 60 points in mid-afternoon when America’s Institute of Supply Management released its monthly report on economic activity.
These reports can be big market movers and this one was no exception. The FTSE 100 quickly regained its 60-point loss once the unexpected good news reached City trading screens. But the rally was shortlived. Within an hour, prices peaked and reversed direction. The Footsie ended the day down 89 points.
Keep in mind that other positive economic surprises in recent months triggered solid multiday rallies, not one-hour wonders. This market is clearly tired.
Fresh data from the US provides further support for my negative view. One worrying indicator is the amount of recent selling by corporate insiders. Researchers at TrimTabs just reported that selling activity mushroomed in recent weeks. The current ratio of insider selling to buying is now 30 to one.
I think it is reasonable to expect some profit taking after a powerful rally such as the one we have enjoyed in the last six months. But the huge gap between buying and selling volume by corporate insiders is eye-popping. It suggests an absence of hope for their own company’s near-term prospects.
Wider measures of US investor sentiment are shifting as well. According to market analyst Jake Bernstein, just 2 per cent of all private investors were optimistic when the current rally began in March. But a whopping 89 per cent are now bullish about shares. The last time optimism reached this level was in October 2007 when the Dow Jones Industrial Average reached a bull market peak.
US investors also appear to be changing their economic focus. Shares began to rally in March when investors saw that a rerun of the Great Depression was unlikely. But their frame of reference has now shifted. Many now focus on the slow rate of economic recovery that is expected in the year ahead.
Corporate profits are higher than many had expected because of costcutting, not revenue growth. But commercial organisations can go only so far along this path. Sales revenue increases are necessary for future profit growth.
Unfortunately, reputable US forecasters warn that the ongoing economic growth spurt could be short-lived.
Last Tuesday’s bullish report from America’s Institute of Supply Management is a good example. Forecasters from High Frequency Economics noted that the figures were boosted by the “Cash For Clunkers” car stimulus programme, which has now ended. They expect future growth prospects to be disappointing.
Other potential problems unnerve US investors as well. My feeling is that Wall Street is unlikely to provide UK investors with much positive help in the near future. For these reasons, I have chosen to ignore my emotions and continue to hold my FTSE 100 spread bet.
But my pessimism is short-term in nature and I expect to terminate my bet soon. My forecast for UK shares to close the year at much higher levels remains unchanged. The main reason for my optimism is that investor psychology has significantly changed since the start of the year. Many were once tempted to sell during rallies to capture profits. But investors who missed the huge rally of the last six months will now probably strive to catch the next up-leg once the current selling wave ends.
If I am right, the next rally could trigger heavy buying from those wishing to avoid being left behind for a second time.
Stock market historian David Schwartz is an active short-term trader writing about his own trades and strategies. Send any comments or suggestions to tradersdiary@ft.com
