Is the FTSE 100 Forecast: Index Surges Through Price Gap, Can it Continue? a fair assessment of this most recent shock to the world markets? Or is it an exercise in self-serving speculation designed to prolong the suffering of stock traders looking for the next penny stock to fall into the hands of fraudulent investors?
One of the biggest challenges facing both analysts and investment managers is how to truly understand what’s going on with the FTSE 100. Any generalisation made on the basis of analyzing the monthly figures will be somewhat inaccurate. The following discussion will briefly examine the basis for this analysis, whether it’s reliable, and then look at the response from markets around the world to the latest economic news.
The reality is that the FTSE is a useful indicator of the mood of the global markets. It is, however, only one component of an overall analysis. A key problem for market watchers is how to differentiate between the influences of the individual elements.
A key component of the FTSE is the retail price index. This component is based on the transactions in the stock market; thus, includes over-the-counter share sales and cash buys by investors. Retail price index includes retail buying and selling by business, retail purchase of stocks by individual investors and corporate share purchases by corporations. These elements combined to allow us to compute the index.
Broadly speaking, you can think of the index as being split into two parts: the ‘total’ index and the ‘seasonal’ index. Seasonal factors can include, but are not limited to, seasonal sales of energy and raw materials. To qualify as a seasonal change, the change needs to occur within a specific span of time – usually the two quarters preceding and following a festive period or trade period.
Indices such as the retail price index are generally referred to as the CPI. They do not include final demand such as manufacturing and wholesale activity, which would not be reflected in these data unless there were serious distortions in the form of trade imbalances.
To use the CPI as a reference point for the retail price index, you need to know how many hundred retailers participate in the index. In order to calculate this number, you need to divide the number of retailers who sell stocks into the total number of stockists. For example, there are four hundred retail shops that sell shares, in the last month.
When you multiply the number of retailers by four hundred, you get two hundred retail shops per month. Therefore, if the retail price index falls, you would expect the number of retail shop to fall, too.
It is easy to see how this would affect the index. However, there is an additional factor that you need to consider when analysing the index. This is the impact of the retail price index on stock prices.
In the scenario where the index spikes (this has happened regularly during the recent economic meltdown), we can see how this would be felt in the share market. This is particularly true if the retail index falls during a period of negative volatility. The index needs to rise before it can affect the retail price index.
As a result, the share market would, in effect, stabilise as the index spikes. This wouldn’t happen in a market where the index was flat, of course. However, it would be highly likely that the index fell before it peaked.
Another consequence of the index surging upwards would be a positive change in liquidity. During a time of economic turmoil, companies would be more willing to accept margin calls. That’s something to think about when the FTSE 100 Forecast: Index Surges Through Price Gap, Can it Continue?