Tweet

 

Email

Email to a friend:

To:

Separate multiple addresses with commas.

From:

Name: Please send me a copy Message:

Verification code

Enter the code from aboveRequired

Send

A glance at the above chart of the FTSE 100 highlights the strong moves experienced recently, as fresh optimism that Eurozone leaders were nearing a permanent solution to the debt crisis, sent the index almost 12% higher in short-order.

Germany and France, the leading powers in the Eurozone, promised last weekend to propose a comprehensive strategy to fight the regions debt crisis at an EU summit on 23^rd October, prompting a rapid improvement in risk appetite.

Jean-Claude Trichet, president of the European Central Bank, highlighted the need to reach a decisive agreement, citing “the high interconnectedness in the EU financial system has led to a rapidly rising risk of contagion.”

Many economists, however, remain sceptical that a comprehensive solution even exists and the fundamental issues at the root of the problem need addressing before throwing more money at it. The Troika, inspectors from the International Monetary Fund, warned that Greece had only made meagre progress in meeting the terms of its bail-out, set in May last year and it is essential that authorities put more emphasis on structural reforms in the economy.

Greek bondholders could be forced to take write-downs of closer to 75%, considerably more than the 21% originally agreed in the summer, forcing financial institutions with Greek exposure to perhaps recapitalise again, the details of which are hazy at best.

Another hurdle for markets comes in the form of the US third quarter earnings season. Aluminium producer Alcoa, was the first to report earnings this quarter and failed to meet analysts’ estimates, sending a wave of caution over the markets. Earnings per share came in at 14 cents compared to forecasts of 22 cents, as European customers dramatically cut orders on the economic uncertainty.

Domestic economic data remains mixed, with a surprise 0.3% increase in retail sales last month, providing struggling retailers a glimmer of hope at a time where trading conditions are extremely tough. Meanwhile, unemployment jumped to its highest level in 17 years, fuelling fears that the country may slip back into recession.

Technical analysis highlights the recent strength, with the FTSE 100 breaking through resistance and closing at its highest level since 3^rd August. The 50-day moving average is also now rising, reflecting the early stages of a new up-trend, with the next major resistance level seen at 5600 from the 200-day moving average. The oscillators are however, considerably overbought with the stochastic at a multi-year high, indicating further weakness is likely. Resistance is now seen at 5395, 5320 and 5200.

In conclusion, it has been an encouraging week for investors and sentiment appears underpinned by hopes that European policymakers will soon announce a miracle solution to the debt crisis, despite a lack of detail at this stage.

Trading volumes, however, remain abnormally light, indicating a severe lack of conviction and unless expectations are managed, it could be a classic case of “buy the rumour / sell the fact.” The backdrop of a slowing global economy is likely to be reflected in corporate earnings and given the markets recent re-rating, I believe there is likely to be further weakness to come.

The banks have been among the main beneficiaries of a recent renewed confidence regarding potential policy developments to stem the Eurozone debt crisis. Barclays (Epic: BARC), Britain’s third-largest bank, has climbed over 30% since last week, as investors speculate that any solution will involve a structured recapitalisation of many European banks, as a result of having to take heavy write-downs on Greek debt (and possibly other indebted nations).

In practice, however, it is hard to scrutinise the logistics of any recapitalisation and this will only contribute in part to an overall solution. The rationale is that alongside other measures, the outlook for the whole region will be more secure, but with the heightened risk of contagion, it is extremely uncertain. Write-downs will impact profitability and capital ratios, while any form of recapitalisation is likely to be dilutive to current shareholders.

Barclays has a large exposure to Spain, both in terms of sovereign exposure and retail operations. Deteriorating funding conditions for Spanish sovereign debt, waning economic prospects and a struggling property market has contaminated funding costs and access for all banks. To put it into perspective, their total exposure to Spain, Greece and Portugal is estimated at £40 billion, double their market capitalisation.

Other European banks are already suffering, with the recent part-nationalisation of Belgian bank Dexia and last week’s profit warning from Deutsche bank. The German bank cited weaker client activity in its investment banking business, providing a clear read-across to Barclays, as investors shy away from the recent volatility.

After selling its asset management arm, Barclays is now heavily dependent on volatile investment banking and low-growth retail banking, leaving the shares heavily exposed to unfavourable conditions for investment banking and the governments imminent decision to possibly ring-fence its retail arm. The fundamentals are not worth considering in detail at this stage, as any decision to write-off more Greek debt will have an immediate impact.

Fitch Ratings, on Thursday slashed ratings on Royal Bank of Scotland and Lloyds after determining they are less likely to receive government support in future. Barclays, which has never taken direct state support, was put on a negative outlook, meaning it may be downgraded. 

The above chart of Barclays illustrates the recent rally with the shares breaking above the 50-day moving average, despite the longer-term downtrend. Resistance was encountered at 192p and with several oscillators appearing overbought, including the stochastic at a five-year high, it suggests there could be short-term weakness ahead.

The initial euphoria has sent Barclays significantly higher in the short-term, but markets dislike uncertainty and as investors explore the details of a possible solution and the implications to shareholders, I believe it will prompt further weakness.

At the time of writing the share price is 187p and near term targets are seen at 174.75p, 166.25p and 150.5p, with a stop-loss marginally above resistance at 195.2p.

This report was written by Mark Allen – Head of Derivatives at Simple Investments Stockbrokers. The writer does not hold a position in Barclays, but client accounts may. The material in this report has come from Simply Charts and Barclays corporate website.