Photographer: Simon Dawson/Bloomberg

Stellar Rally Sends U.K.’s FTSE 100 Into Critical Technical Zone

The FTSE 100 Index’s winning run has made the U.K. megacap gauge one of the best equity bets among developed markets this year. One technical sign is showing the rally might be at risk.

An 11 percent jump in 2016 has propelled the FTSE 100 into what technical analysts call overbought territory, implying that gains might have come too quickly to hold. The zone is reached when the resistance strength index surpasses 70, and a pullback from there could trigger declines. At nearly 74, the gauge of momentum is the highest it’s been since May 22, 2013, when the equity index hit a high before falling 12 percent in about a month.

A weaker pound and increased stimulus from the Bank of England in the wake of the country’s vote to leave the European Union have propelled U.K. shares to a more than one-year high. But this technical signal prompts some caution, according to Saxo Bank A/S trader Pierre Martin. He says the FTSE 100 could slide as much as 7 percent in the second half of the year.

“The FTSE is now in overbought territory, so we might be a little bit more cautious,” Martin said from London. “Even if we have seen a lot of good things, technically speaking, in all indices recently, the more we go in overbought territory, the more chances we have to see a small correction.”

Before that happens, Martin says there’s a chance the FTSE 100 will hit its 2015 high of 7,103.98 by the end of the summer, particularly if the pound remains weak and oil gains momentum. Those two factors are key for the index, which is mostly made up of multinational companies including energy producers, lenders and drugmakers. JPMorgan Chase & Co. estimates FTSE 100 members derive 72 percent of their revenue from abroad.

The U.S. bank reiterated its overweight rating on British shares on Monday, citing currency weakness, overseas sales exposure and cheap valuations. On a price-to-book basis, the gauge’s multiple of 1.9 is about 11 percent lower than for the MSCI All-Country World Index, data compiled by Bloomberg show.

The recent rallies in the S&P 500 Index, which has set nine fresh records in a month, as well as in Germany’s DAX Index, now in a bull market, are also lending support to the argument that the FTSE 100 will go higher before it starts its decline, according to Martin.

In technical analysis, investors and analysts study charts to identify trading patterns and forecast price changes. The RSI measures the magnitude of recent gains and losses for a given security. In May 2013, the FTSE 100’s RSI surpassed 80, one of its highest levels ever. The equity index reached an almost six-month low the following June as miners tumbled with metal prices on concern that a cash crunch in China would reduce demand.

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