Is the FTSE 100 about to rally?

After a number of weeks of underperformance, is the FTSE 100 poised to turn higher?

While the DAX and S&P 500 have moved back towards the peak of the current rally seen in early June, the FTSE 100 has struggled to hold its ground.

Sector underperformance holds the FTSE 100 back

In part, this is due to the make up of the index. While the S&P 500 can boast some high profile tech stocks like Apple and Microsoft, which have helped to drive it higher, the UK’s premier index has very little in the way of technology to drive them higher. In addition, its heavy focus on banks has meant that this sector’s underperformance has weighed down on the index overall, allowing the more industrial DAX and the more broad S&P 500 to pull ahead overall.

As well as weakness in the banks, the index has been hit hard by the poor performance of its big oil stocks, BP and Shell, both of which are down over the past three months, by 13% and 19% respectively. The sector makes up around 10% of the index’s weighting, acting like a millstone around its neck when it is declining.

Sterling strength costs investors dear

The rebound in the pound has also meant that the index is lagging behind its peers. While the euro is also rallying against the dollar, the pound has been even stronger, reducing the attractiveness of UK stocks to foreign investors. The renewed move higher in GBP/USD over the past two weeks will have added to this underperformance, with no sign that sterling’s strength against the greenback is likely to reverse.

Weak breadth offers an opportunity

A rising tide does lift all boats however, and while the price action in the index has not been noticeably bullish since early June, the index may yet be able to push higher.

Recent weakness pushed the percentage of FTSE 100 stocks above their 20-day simple moving average (SMA) down to 25%, its lowest level since early April. As the chart below shows, such weakness can often point to near-term buying opportunities, as was the case in October and December last year, and in March of this year.

In addition, just 9% of the index is at a 20-day high. This is usually consistent with the potential for a near-term bounce, more so than when the readings are high. For instance, in early June, over 60% of the index was at a 20-day high, and this was followed up by steep losses.

Investors looking for a rebound may take some comfort from these weak breadth readings, which are likely to be better for longs from a risk-reward perspective.

FTSE 100 technical analysis

For the index, the key to further upside lies in a break above 6300, and then through 6500, the early-June high. Until this happens, the index remains in its 6000–6300 range.

Admittedly the buyers have stepped up when needed around 6000; weakness in early June and in the second week of July has been met with buying, and the general ‘risk-on’ atmosphere for equity markets worldwide will likely drag the index higher.

This view arguably remains in place unless we see a drop below 5900, which would bring the previous 5600 support zone into play.

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