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FTSE 100: Bear Market Or Blip?

The first quarter of the year has been a roller coaster ride for investors, with many indices across the developed world slipping into what is technically known as bear market territory, before going on to stage a strong rebound throughout February and March.

The FTSE 100 is now close to its break-even for the year to date, despite falling by 11.4% during the five weeks to the 11th February. Behind all of this price action has been a single common theme —commodity prices and commodity producers.

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Initially, tumbling commodity prices drove a significant deterioration of earnings across the commodity space, prompting a wave of dividend cuts, disposals and restructurings. More recently, oil and industrial metals prices have embarked upon a sharp and sustained recovery and consequently, investors have piled back into the sector.

Bear market or blip?

After seeing such wild swings in equity prices and with the FTSE 100 now so close to its break-even level for the year, many investors could be forgiven for asking if this is really the beginning of a bear market or if it is just a blip. The truth is that we probably won’t know for at least another three to six months.

The oversupply that has driven the sell-off is yet to show signs of dissipating and although the number of active oil rigs in the US has fallen by almost 50% since May 2015, suggesting that some producers have come off line, global oil output remains at record levels and North American commercial crude inventories are still close to an 80 year high.

The fact that oil and other materials prices are rising, even as this oversupply persists, suggests that investors could now be betting on production shortages over the medium to longer term, given the extent to which capex has been cut across the commodity space in recent quarters.

Implications

Nevertheless, it will be difficult for anybody to predict where commodity prices will be in six months time without knowing first, how sovereign and commercial producers are likely to react to the current recovery.

If, in six months time, the rig count has begun to creep back up in the US and/or capex is rising once again at the global level, then it is likely that the current rebound will fade into memory as a mere blip at the beginning of a bear market for the FTSE indices.

If, on the other hand, US shale stands pat and industry wide capex barely moves then it is quite conceivable that commodity shares could cling onto much of their recent gains. This would be great news for the FTSE 100 and FTSE 250 indices in 2016 and, given the heavy weighting toward raw materials in each, it could also mean that a bear market is avoided.

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James Skinner has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

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