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Action in US top 100 worrying

Lesley Beath  |  04 Feb 2014Text size  Decrease  Increase  |  

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The views expressed in this report are those of Lesley Beath and may differ from Morningstar's views.


Disclaimer: To the extent that any content in this report constitutes advice, it is general advice that has been prepared by Lesley Beath without taking into account the particular investment objectives, financial situation and particular needs of any individual investors. If necessary, you should consult with a licensed investment adviser or dealer in securities such as a stockbroker before making an investment decision. 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.


Last week we reviewed the US T-Bond/S&P 500 ratio in detail, noting the change in character that suggested the US equity market was likely to break its November 2012 uptrend. The ratio continued to push ahead over the course of the week and the VIX also pushed higher.

I believe both have more upside potential in the short term. So there is no change to the view put forward last week - there is a high probability of a correction toward the September 2011 uptrend. At this stage that uptrend runs through approximately 1660.

A pullback to that level would fit with the character of the advance since 2011. Not a real problem really. But what if it is worse? What if that uptrend is violated? Are there any signs that point to that possibility?

I would suggest that there are a couple. Firstly, as I mentioned earlier in the year, the Decennial cycle points to a tough year ahead and action in global equity markets gives little cause for optimism. Many markets have been trending lower for quite some time and there is nothing to suggest the decline is over.

China did post a weekly "key reversal" the week before last, and although that is noteworthy, there needs to be some further follow-through to signal a potential turnaround. As mentioned last week, the UK FTSE and the Japanese Nikkei exhibit a weakening price structure and I believe both have posted a medium-term peak.

In the US, action in the top 100 stocks is worrying, and importantly the banking sector looks vulnerable. The S&P Banks index displays a deterioration in upward momentum and stocks such as Goldman Sachs (GS), JP Morgan Chase (JPM), Morgan Stanley (MS) Bank of New York (BK), US Bancorp (USB) and Citigroup (C) all posted monthly key reversals in December.

As monthly key reversals often mark peaks of longer-term significance, the action in the banks should make investors sit up and take note.

While equities look vulnerable, the bond market, which was sold off sharply in the second half of last year, has been improving in 2014 and it looks like further upside is possible. Are savvy investors switching back into bonds?

So yes, I would conclude that although there are no concrete signs that this current weakness in the S&P 500 could morph into something deeper than we have seen for the past couple of years, there is enough evidence to suggest that we should remain very cautious.

And as US Bonds are moving to the upside, so too is the Dow Jones Utilities index. I drew attention to this a few weeks ago, highlighting the fact that it had bounced from its 2009 uptrend. It has been outperforming since the beginning of the year, in line with the outperformance of bonds versus equities.

It could be argued that this bounce from support could be suggesting that the Dow Industrials and the S&P 500 may also bounce from their near-term support levels, which are currently being tested.

I can't dismiss that possibility, but it could well be that this strength in the Utilities index may represent a flight to less-riskier assets.

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