Only after ‘head and shoulders’ have passed will it be time to buy

Since the start of August the FTSE 100 has had more in common with the Grand Old Duke of York marching his men to the top of hill and back down again than any raging bull or growling bear.

UK government bond prices have oscillated similarly, albeit only since about September.

In spite of this, the Investment Club has managed a fourth consecutive all-time high of £3.12 for its unit price in October. Can the club’s analysis offer an insight into the eventual direction of the financial markets?

In the long term both the financial markets and the general wealth of the average consumer will diminish.

An example of how this creeping poverty comes about is seen in the plight of the fastest growing proportion of the population: pensioners. If you had retired in the late 1990s you would have received about two-thirds more pension than you would today. This is because with-profits payouts have fallen and the value of equity pension pots have also dribbled away in real terms.

On top of this, annuities are at record lows. Even in the past two months they have fallen 3 per cent, while Prudential estimates that pensions will drop by 60 per cent due to inflation over the next ten years.

Therefore, over this decade the rich pensioners of the late Nineties with the spending power to boost economic growth will be dying off and being replaced by very poor pensioners with much less spending power. By the start of the next decade the overwhelming majority of pensioners will be poor.

The slow-burn poverty will be reflected in the population as a whole. This will come about by, for example, net disposable income falling – down 0.8 per cent in 2010, accelerating to 2 per cent this year. By unemployment rising – up 0.8 per cent in October to 8.1 per cent in a rising trend – real earnings growth will fall and smaller companies, like Best Buy, will go into liquidation.

Underlying this long-term poverty will be the short-term fluctuations that the club has to contend with. Here our analysis has some guidance.

On 23 August the Dow experienced a “Dead Cross”, every bit as negative an omen as it sounds, when a market’s 50-day moving average crosses below its 200-day moving average. Typically, the index is falling before the Dead Cross confirmation. When confirmation comes, the index has started to consolidate or actually rise before it starts to fall again re-establishing the down trend.

In the UK the FTSE’s price action is building what technical analysts call a “head and shoulder” formation, which is an ominous down-side pattern. How far down can we expect the markets to go? For the FTSE, we are looking for a fall to about 4,500 before Christmas. The Dow should fall below the 10,500 mark in the same time frame.

With the FTSE at 4,500 the club will use its small cash pile to buy something volatile like Lloyds, the bank least exposed to the EU debt crisis. The purchase will be made to try to mitigate losses in our gilt portfolio as the stock market rises from this low point.