Today, we are going to continue our analysis of the market width indicators and look at the next one – UK ZEW Economic Sentiment. It is an economic survey, alike the Industrial Trends Orders, which we have presented earlier.
The ZEW Economic Sentiment is a fusion of the sentiments of approximately 350 economists and analysts, regarding the economic future of United Kingdom for the next six months. The survey shows the balance between those analysts, who are optimistic about UK’s economic future and those who are not. The examination is conducted on the monthly basis.
An index value greater than zero indicates optimism while a value below zero indicates pessimism. The value of +100 means, that all the responders are optimistic about the future and -100 means, that all of them are pessimistic about it. As we can see, the indicator has got a very simple and easily to analyze form. However, as usually, we are going to examine the ZEW dynamics, which is a measurement of the acceleration and direction in which, is the indicator changing, in comparison with the level one year back in time.
Let’s take a look on the chart below, which presents FTSE250 and UK ZEW dynamics. This time, we have chosen FTSE250, because it provides a better tracing of the small companies behaviour.
We can see here a lot of peaks and bottoms of UK ZEW dynamics. The level of indicator is usually somewhere inside a channel of -50 and +70. However, there are periods, when the value fluctuates in a narrower area (i.e. 2004-2009, 2011-now). These situation have been considered in our analysis too. So, what dependence between these two paths can be found?
If the UK ZEW is going up, it should indicate more and more optimistic opinions about the future UK economy. In these situations, if the experts are right, the economy will start to perform better in the next 6 months and the market should perform better too. Likewise, the falling ZEW dynamic means the deteriorating future prospects and should be sign of worse or even harsh times coming for the investors.
After a few tests, we have come to the conclusion, that neither the peaks nor the bottoms are a reliable indicator of what will going to happen with the FTSE250 within a year or two after their appearance. There have been some correlation, but not so strong as we would like to see. However, we have established, that a situation, when the ZEW dynamics crosses the level of -30 from the bottom is a very good sync point of a coming bull market. In this situation, after a bottom, the indicator is going up and some time have passed, after the first good ZEW results have appeared (it is important, because the survey asks about the situation for the next 6 months).
Let’s see these sync points on the chart below:
We have 8 such situations since 1993. The last bottom was too high and due to this fact is not marked by us. We have checked, how the FTSE250 was behaving during 2 years (around 500 trading days) after the sync point. The results are presented on the chart below:
As we can see:
- one extremely negative path (12.5%)
- one neutral path (12.5%)
- six extremely positive paths (75%)
There is a very strong dependence and our sync points have pointed out a very great moment to invest in 75% cases. The average return is +31%. We have established a median for the FTSE250 performance during 2 years periods. The result is +19%. Our strategy beats the market about 10-12 p.p., which is a very good outcome. In conclusion, we have 75% chance, that the index will go up during 2 years after the sync and it will beat the market results.
Nowadays, we are after the bottom in the end of 2014. The bottom was above the level of -30 (-29,9), but very close to it. Due to this fact, we would like to consider this bottom as an another, correct signal. Let’s take a look on the chart below, which presents the path of FTSE250 after this sync point:
FTSE250 has risen about 8% in a year and the path shape indicates, that we are dealing with a bullish tendency. The average return for the seven, previously analyzed, growing paths isaround 17 p.p. (during the second year after the sync point). Hence, we can expect, that the index will rise on average, about 2700 points in the next 12 months. There is a 75% probability, that it will end the 2016 somewhere in the channel of 17,700 – 21,000. However, we believe, that it will be closer to the bottom of this interval, due to the fact, that the most positive paths have been usually higher at this point in time.