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Could this be a continuation pattern?

Lesley Beath  |  26 Apr 2011Text 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.

 

Reviewed this week

 

 

Please note: before making an investment decision, Morningstar recommends you read the fundamental research available on these stocks.

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.


Overview

Let's start with a simple question.

Does last week's strength the in the Australian market cast doubt on the validity of the 'key reversal' that was discussed in the last report?

No, this strength in itself is no reason to question the key reversal. In fact, it will not be negated until the All Ords breaks above the April 11 high at 5070. On the ASX 200 it is the 4975 level.

But last week's action did cloud the issue somewhat. This is because a number of stocks and sectors broke above their major barriers. This is positive action, and follows topside breaks in a number of stocks over recent weeks. However we are faced with the same situation that has placed a cap on the market many times over the past few months - the major resource stocks and the banking stocks are not expected to move to the upside simultaneously. In the near term, it is the banking sector which has the capacity to move higher; at this stage the large resource stocks do not exhibit the same upside potential.

At the end of the last report I posed the question 'what would alter the near term cautious outlook?' The answer was 'the same thing that has been in focus for the past few months - a simultaneous topside break in the Banks and the Materials. And a break below support in the VIX and the US T-Bond/S&P ratio'.

Well, none of that has come to pass.

So despite last week's strong rally in US equities, and indeed across a number of global markets, until there is a confirmed topside break in the US and in Australia, the situation is still tilted to negative side.

But there is an alternative outcome and this needs to be discussed, so let's take a look.

In the US, the S&P 500, the NYSE Composite, and the Nasdaq, are all in the vicinity of their recovery highs and a topside break would, in the case of the S&P complete an 'inverse head and shoulders continuation' pattern. This pattern is a positive chart formation which opens potential for a significant move to the upside.

 

S&P 500 Index (Spot) chart

(click image to enlarge)

 

As way of background information, a head and shoulders pattern is a reversal pattern that is often found at the end of an extended uptrend (or downtrend). According to the ASX website, the head and shoulders reversal signal is one of the most reliable reversal signals. 'It is created as a result of three congestion areas. The first forms a shoulder, the second the head and the third a second shoulder. The head congestion is above the shoulders, which both form on the same support line and within the same basic range. In the case of a head and shoulders top, the reversal of a bull market trend is signalled'.