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ASX correction may have further to run

Lesley Beath  |  06 Feb 2017Text size  Decrease  Increase  |  

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Momentum indicators on the ASX are not encouraging at this stage and caution should be exercised in the near term, technical analyst Lesley Beath says.

 

My school motto was "facta non verba" (deeds not words) and I think of that quite a lot--in regard to many things. In bringing that motto into the analysis of financial markets, I often say in my weekly reports to "look at what is actually happening, instead of what you except to happen".

In doing that you will be less fooled by personal expectations.

So, given all the news that is making headlines regarding Trump's actions, it is interesting to see the US market so relatively quiet.

For all the news that has come out of the US in recent weeks, it appears the US equity market is just plodding along, ignoring what is going on around it.

It seems quite happy just doing its own thing!

Last week we discussed the break of the 20,000 level on the Dow and the topside break of the very tight range that had been in place since mid-December.

I noted that the Russell 2000, the Dow Utilities, and the S&P Banks Index had not followed the breakout, and that we should wait for them to follow suit before becoming too optimistic.

They still haven't broken topside, but they look quite constructive, and only minimal strength is required for the breakout.

The VIX is also still sitting at an important support level; it appears to want to drift lower, and if that is the case, I think the US equity market will continue to push higher. That looks like the most likely scenario at this stage.

The Australian market is less constructive than the US.

The consolidation/correction that began in early January may have further to run. I noted last week that the ASX 200 had bounced from its initial support but momentum indicators are not encouraging at this stage.

And with the weekly key reversal on the ASX 100 Industrials a few weeks ago, caution is warranted in the near term.

The resource side of the market is giving some mixed signals. I noted last week that both BHP Billiton (ASX: BHP) and Rio Tinto (ASX: RIO) had broken above resistance, but that copper had failed to do likewise.

I was inspired by the break in BHP and RIO, but they both pulled back last week and BHP actually closed the week below the resistance it had conquered the previous week.

The ASX 100 Resources Index declined over the course of the week but it is still above the 2011 downtrend.

Copper failed in its attempt to push above the November high.

At the moment, the resource side of the market is unclear, and in the short term at least, there appear to be less-risky opportunities elsewhere.

One of those potential opportunities doesn't make much sense given the current interest rate environment--but let's take a look at it anyway.

I am talking about the REIT sector.

The sector was hit hard between August and November on the threat of rising interest rates. It then rebounded sharply, rallying up to test the 200DMA. It was deflected and then retreated.

It has steadied over the past couple of weeks, both in price and relative-performance terms.

A look at the iShares US DJ Real Estate ETF presents a similar profile, although it has not pulled back after rebounding from the November low.

A review of the major components of the ASX REITs highlights a similar price structure in many of the components--although LendLease Group (ASX: LLC) and Investa Office Fund (ASX: IOF) present a different profile.

What is interesting is that the charts suggest risk is to the upside in the sector: given the sector would face headwinds in a rising interest rate environment, they could be suggesting rates will stay on hold over the short to medium term.

Or perhaps it's just a simple matter of being oversold and due for a rebound.

The other sector that deserves a mention this week is healthcare.

The sharp spike in CSL Limited (ASX: CSL) on 19 January pushed the ASX Health Care Index above the downtrend from the July high. It has spent the past couple of weeks consolidating that gain.

If we look at the price structure, the index displays a "flag" formation. This formation and the similar "pennant" are positive.

Here is a description from Investopedia: "The flag and pennant patterns are two continuation patterns that closely resemble each other, differing only in their shape during the pattern's consolidation period ... a flag is a rectangular shape, while the pennant looks more like a triangle."

"These two patterns are formed when there is a sharp price movement (the flag pole) followed by generally sideways price movement, which is the flag or pennant.

"The pattern is complete when there is a price breakout in the same direction of the initial sharp price movement. The following move will see a similarly sharp move in the same direction as the prior sharp move ... the flag or pennant is considered to be flying at half-mast, as the distance of the initial price movement is thought to be roughly equal to the proceeding price move.

"The reason these patterns form is that after a large price movement, the market consolidates, or pauses, before resuming the initial trend."

I would prefer to see these patterns form on individual stocks rather than an index, but because CSL is displaying a similar pattern (although its pattern is more of a pennant) I think the pattern is valid.

As an aside, a lot of people look upon the names of chart patterns in a derisive manner. So don't get too bothered by the definition, it's really just a name, among others, for a continuation pattern.

Volume plays an important part in these patterns: it should be heavy on the initial spike, and then drift lower as price consolidates--as it is for CSL.

Interestingly, ResMed (ASX: RMD) also spiked higher, on January 24 and 25. It has since drifted back, but the pattern does not have the "right look" to classify as a flag. I may be incorrect--time will tell.

There is nothing negative about the current price structure, but the $8.32 level is strong resistance, and until price can push above that, the medium-term outlook is neutral.

The currency markets are still unclear, in my opinion. The Australian dollar popped up last week but it remains below the combined resistance of the 2011 downtrend and the 2016 highs.

The Australian Trade Weighted Index (WTI) is a different matter--it has broken above resistance and further gains are likely.

 

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More from Morningstar

• Has the Australian market pullback ended?

• Don't bet on resources moving higher

 

To the extent that any content below constitutes advice, it is general advice (or, in New Zealand, a "class service") that has been prepared by Lesley Beath as a Morningstar authorized representative (ARN 469614) without taking into account your particular investment objectives, financial situation or needs. If necessary, you should consider the advice in light of these matters, consult with a licensed financial advisor, and consider the relevant Product Disclosure Statement (Australian products) or Investment Statement (New Zealand products) before making any decision to invest. Opinions expressed herein are subject to change without notice and may differ or be contrary to the opinions or recommendations of Morningstar as a result of using different assumptions and criteria. The author does have an interest in the securities disclosed in this report.

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