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Risky time to increase exposure

Lesley Beath  |  14 Feb 2012Text 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.


In the last report we focussed on the resistance that the BRICs and the Australian resource stocks were then facing. This was in conjunction with resistance on copper and nickel, and support on the VIX and the US T-Bond/S&P 500 ratio. I did not believe that a topside break was imminent, and felt that a pause was likely. Last week's action has reinforced that view and increased the odds of some near-term weakness.

Brazil, Russia, India, and China put in mixed performances over the week, but none have broken decisively above resistance. The ASX Materials index pushed marginally above the 2011 downtrend early in the week, but could not hold the break. And the three majors, BHP Billiton (BHP), Rio Tinto (RIO) and Fortescue Metals (FMG) do not appear to have the ability to push the index higher in the near-term. Until these can break above their respective barriers, we should adopt a near-term cautious outlook. That is not to say that we cannot get further upside over the next few months, but given the gains posted in January a short-term pullback is likely. This would be a normal development, providing a lower-risk entry point.


S&P/ASX200 Materials chart

(click image to enlarge)


In the US, the S&P 500 ended the week relatively flat, but is overbought and I believe that a pullback is imminent. The VIX bounced strongly from support last week, gaining 29%. The support, which was highlighted in the last report, was associated with the October 2007, May 2008, April 2010 and April 2011 highs in the equity market. The VIX hit a low of 14.3 in April 2011, so the recent low at 16.1 was marginally higher, but you still have to be wary when complacency nears those low levels. I suggested last week, that given that the VIX traded around 10 between late 2004 and early 2007, the current level did not necessarily mean that a turn in the equity market was imminent; but investors tend to focus on recent history and I am of the belief that any rise from current levels will increase the odds of a pullback in the US equity market.


S&P500 Index (Spot) chart

(click image to enlarge)


Volatility S&P500 chart

(click image to enlarge)


Another measure of sentiment, or complacency, is the AAII (American Association of Individual Investors) survey.

This survey measures the percentage of individual investors who are bullish, bearish, and neutral on the stock market for the next six months. The long-term averages are: Bullish - 39%, Neutral - 31%, and Bearish - 30%. Last week the level of bullishness rose to 51.6% and bearishness dropped to 20.2%. Whilst this bullish reading is not excessive, it does show that investors are relatively complacent. And this fits with the relatively low level in the VIX. So some short-term caution here as well.

We also looked at the US T-Bond/ S&P 500 ratio last week, as it was approaching the late October 2011 lows; that level was important and the ratio dipped below it early in the week before reversing sharply on Friday. The jury is still out here, but I think risk is skewed to the upside which should keep a lid on the equity market.


US T-Bonds / S&P500 ratio chart

(click image to enlarge)