European shares' blistering rally of 60 percent from March lows is poised to spill over into the early months of 2010, but technical analysts say the market will become vulnerable to deep corrections thereafter.
Chartists, who provide a view on market performance based on patterns in the graphs of securities or indexes, said the stock market's ascent next year will be nowhere near its performance in 2009, which saw equities propelling in one direction for most of the year after slumping 45 percent in 2008.
"It looks quite constructive for 2010, but I don't think the next year is going to be like this year. We are going to get a deep correction probably in the first half of 2010," said Phil Roberts, technical analyst at Barclays Capital.
After hitting a record low in early March this year, the FTSEurofirst 300 index of top European shares has surged 59 percent, while Britain's FTSE 100, Germany's DAX, France's CAC 40 and pan-European DJ STOXX 600 have climbed 57 to 64 percent during the period. "We have seen a huge rally this year and it's more than a bear market rally, but the upside will be limited in the first half of next year," said Michael Riesner, head of equities technical analysis at UBS Investment Bank.
"The risk of a significant setback is much higher in 2010 and that means we could easily see a 20 to 25 percent move on the downside from the top," he added.
Chartists, who predict market trends by looking at technical measures such as relative strength, moving averages and Elliott waves, said the DJ STOXX 600 index was struggling around 248 - its 38.2 percent retracement of the major fall from mid-2007 to March 2009. If the index could convincingly break the 251-252 area during the holiday period, then that will set the stage for a decent move on the upside, analysts said. The index rose 0.8 percent to 249 points on Friday. Riesner said the STOXX 600 had potential to rise to 280 points next year - roughly the 50 percent retracement - but that was the maximum target for the year and the index could even slip towards the 200 level in the second half of 2010.
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Technical analysts noted that the inverse head and shoulders pattern triggered by the FTSE 100 index in July - a bullish pattern - pointed up to about 5,600-5,700 points from around 5,245 at present.
An inverse head and shoulders pattern is used by chartists to predict the reversal of a current downtrend. The first and the third troughs are seen as shoulders and the second peak forms the head.
"I don't think this is the resumption of a long-term bull cycle, but the rally is probably incomplete and is going to spill over into the next year," said Cliff Green, an independent technical analyst.
One signal for an upleg in stocks over the next few months could be the triggering of a bullish symmetrical triangle by the FTSEurofirst 300 index, now at 1,025 points.
The index has been consolidating in a triangle formed by the highs and lows of the past month, but in the last few days it has been testing the top of the triangle.
Late last month it confirmed support on its 100-day moving average and on an uptrend line dating back to March, while monthly oscillators, including momentum and MACD (moving average convergence divergence), remain positive. This suggests a good chance of the index triggering the triangle, which would point up to around 1,090 points - up more than 6 percent from the current level. Symmetrical triangles are classic signals of the continuation of an uptrend. "The outlook is for a recovery next year but I just feel that the market has moved so quickly that it just really needs to let the economic conditions catch up," said Julian McCormack, technical analyst at Brewin Dolphin.
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