US market awakes from its slumber
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From a contrarian viewpoint, the increase in fear we have seen in recent times is a positive sign, technical analyst Lesley Beath says.
The US market finally awoke from its slumber last week. The 2 per cent drop in the S&P 500 pushed the index below the lateral support that has been in place for several months. That break of support follows the break in the Russell 2000, which we discussed in the last report.
If you remember I noted that the Russell can often lead the major averages and the break below support, the week prior, was a negative development.
Last week's action does not come as a great surprise, but does it give any strong clues about the medium-term outlook? Not really.
Risk remains to the downside as it has for some time now, but at this stage there is no indication that a major trend change is imminent.
That could all change with the result of the US election, but for now, the S&P remains above its 200DMA, so from a technical perspective, no major damage has been done to the chart profile. That said, the path of least resistance remains to the downside.
But that seems to be a widely-held view, and from a contrarian viewpoint, the increase in fear that we have seen in recent times, is a positive sign.
But there is no point second guessing the market. Increased volatility might be good for short-term traders, but it is not necessarily the friend of longer-term investors.
If we look at the three key indicators of sentiment in the US, all are suggesting a cautious environment. Two are moving quickly to a somewhat extreme reading:
The index is not yet at an extreme but it jumped by almost 40 per cent last week (to the 23 level). It sits below the highs of the past 12 months. It is likely to move higher over the next week, so let's see what it does when it nears the upper limits of the range (30).
The AAII Sentiment Survey
Optimism sits at 23.6 per cent. This is below the historical average of 38.5 per cent. But bullish sentiment has been below its historical average for 52 consecutive weeks; and for 85 out the past 87 weeks.
Neutral sentiment remains high, as it has been for the past 40 weeks.
Bearish sentiment is above it historical average, but not by much.
So, there is not a major change in the overall AAII survey. The current readings are not too dissimilar to what they have been for a while now.
The CNN Fear and Greed Index
There has been a big change here in recent times. Last week's reading registered "Extreme Fear". The index is now heading toward the lows of the past few years.
It's not there yet ... but by the look of it, it won't take much to push it there. It is only marginally above the levels of early this year.
So, we have the situation where the S&P 500 is on its 200DMA and sentiment indicators are approaching fear levels. That combination can mean that a buying opportunity is approaching, but with the US election this week, volatility, rather than opportunity seems likely.
In the last report we highlighted the US T-Bond/S&P 500 ratio, noting the unusual behaviour of late. The bonds were on significant support and I noted that it was a "critical juncture for the bond market and we should get a resolution relatively quickly". That support has held, so far.
Bonds (price) nudged higher over the week: that resulted in a reversal in the ratio. Medium and longer-term risk remains to the downside, as it has done for several months now; but given the significance of support, a counter-trend bounce cannot be ruled out. That would make sense, given the uncertainty around the US election and its aftermath.
If we look elsewhere in the global equity market place, the UK FTSE and the German DAX have been unable to break above resistance for the past couple of months. They succumbed to selling pressure last week, with the FTSE down 4.3 per cent and the DAX off by 4 per cent.
The Japanese Nikkei has battled against resistance for several months also. It posted its largest weekly loss since early July last week, down 3 per cent.
None of these markets inspire any confidence.
The Australian market lost ground yet again. The All Ords pushed below support last week. Momentum remains weak. The ASX Banks dropped by 5.4 per cent in the eight sessions to last Friday. That came after the index once again tested a major resistance level.
The All Ords shows no obvious support levels in close proximity. However, if we look at the ASX 20 Leaders Index, support is quite well-defined. Sometimes if there are no clear support levels on the major market indices, we can get some guidance elsewhere.
And as I am of the opinion the 20 Leaders can outperform over the medium term, action in that index is important.
The support on the ASX 20 Leaders captures the gradual uptrend from the February lows. I have taken the intra-day, as well as the closing, lows. You will see, as you study that chart later, that support is in close proximity.
I also note the ASX Small Ordinaries is close to support as well. That support is the combination of the 200DMA, a 50 per cent retracement of the 2016 advance and the upper limits of the 2013-2016 range. That is significant.
If these support levels can hold this week, amid the anticipated volatility, then we may be pleasantly surprised by the action over the next month or so.
But no-one really knows what the next few days will bring, and how markets will react. Global equity markets are not suggesting a positive outcome is likely, but the markets are often full of surprises.
Probably the best outcome would be to see sentiment indicators weaken to even further extremes over the next few days. That would mean some more pain, but it could create a buying opportunity.
Finally, a quick word on commodity markets.
Was hit hard last week, after it failed to push above the resistance that we have been monitoring. It is still above the 200DMA, so basically it remains in a medium-term sideways trend. No surprises here.
Has strengthened in recent weeks but remains in a sideways range.
This is interesting as it has pushed above a major resistance level. This could end up being a false break; let's keep an eye on this one.
Has pushed higher as investors have sought a safe haven. My view has been that lower levels are likely and that view remains intact at this stage.
Over the next few days keep your eye on the downtrend from the July high--it currently comes in at approximately $1327. That could cap upside potential.
Interestingly, the US T-Bond peaked at the same time as gold: it too will face resistance from the July downtrend.
A retreat by both, as that trendline is tested, could be viewed as a positive development for the US equity market. Alternately, a break above that trendline, is likely to signal more nervousness.
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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 not have an interest in the securities disclosed in this report.
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