Last week when Trump spoke in front of Law makers the FTSE100 surged to record high. Today the euphoria has been replaced by uncertainty or profit taking whatever you want to call it. Many people think the rally was overdone so taking profit is a natural thing. Yet, when you look at valuations and rising interest rates it is hard to believe the advance can be sustained. The combination of flat earnings and soaring stock prices has pushed the P/E ratio on the S&P 500 to 26, one of the highest ratios in history. These swings in valuations are associated with boom and bust cycles.
This does not mean the bubble will burst, indeed many bubbles have grown bigger before bursting. What I am saying is that if you are a long term investor be cautious. If you are a short term trader, money can be made up and down. After record highs last week stock markets are pulling back. Is this the start of a longer correction or a pause in the uptrend? In the short term there are various ways to interpret the pattern.
Right now I have conflicting indicators, for example my sentiment indicator has turned bullish but the S&P appears to have turned down after completing five waves up. In terms of Elliott wave, rallies end after five waves up. The pound is expected to rally, this would be negative for the FTSE, however, I note that the FTSE could be losing its correlation with the pound. Since the high on 2nd March both FTSE100 and GBP/USD have declined.
When sentiment is bullish the odds favour a rally, therefore we could be in scenario #2 on the chart. In this scenario the pattern is a rising wedge inside wave b (circle). When I say the S&P is expected to decline I mean over a week or longer. In the short term it could rally if we assume that the low so far is the bottom of a first wave. If it’s the first wave of a five-wave decline the next move is a second wave up, and second waves in general retrace a large portion of the first wave. This means the S&P could easily go back to 2390-2400 to complete the second wave of the decline. This move would help the FTSE rally above 7400. This is why this scenario is possible and because sentiment has turned bullish I would not be surprised if the FTSE rallies from near current levels.
Alternatively we have an expanded flat [(a),(b),(c)] inside wave c (circle), this is scenario #1. This pattern implies that wave b (circle) is already complete and we are now in wave c (circle). Further downside is expected in the short term with this scenario as wave (c) down unfolds. This is confirmed by the S&P (expected to decline in five waves) and the pound (expected to rally).
Because of the lack of clarity with regard to the next move I recommend to step aside and wait for a better signal to trade. The FTSE could go either way in the short term, if the pattern is a rising wedge [(i),(ii),(iii),(iv),(v)] wave (iv) will end below 7300 and the next move will be wave (v) above 7400.