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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

• Overview
  Difficult and volatile times to continue. More...
• Newcrest (NCM)
  A win-win situation? More...
• Troy Resources (TRY)
  New all-time highs. More...
• Kingsgate Consolidated (KCN)
  Constructive action. More...
• Iluka (ILU)
  Take profits. More...
• Woolworths (WOW)
  Boring is good in this environment. More...
• Lend Lease (LLC)
  Risk is still to the downside. More...

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

The final comment in the last report sums up the outlook for the next few months... "despite the reversal last week, and the fear levels that were attained, I think there is scope for further volatility and weakness over the next couple of months. I have been saying for some months that a sustainable Buying opportunity might not present itself until Q4 and that view remains".

The severe pullback at the end of the week came as a bit of a surprise, as I had thought that we could see a bit more upside before the onset of another decline. This was particularly the case in the US where a pullback to the neckline of the head and shoulders top formation would have been an opportune time to reduce exposure again.

We can't rule out the possibility of renewed strength over the next few weeks which could take the S&P back to the 1250 level, but investors are very skittish and their mood swings are creating a difficult environment.

If we look at the Australian market, the Materials index and the individual banking stocks rallied back to their resistance levels early in the week, and then declined. A large number of individual stocks have done the same, with price rising to test either the 200DMA or the strong resistance which, until late July/ early August had been solid, and in many cases, long-term, support. This resistance is powerful and volatile trading below those levels could continue for the next couple of months.

And what about the VIX?

We looked at this in some detail last week, highlighting the previous occasions when it had pushed up to the 48 level. It was suggested at the time that "unless there is to be a major crisis, (those levels) mark a height of fear that is unlikely to be surpassed. This is not to say that we cannot get another bout of fear in another month or two, but for the time being there has been a reprieve, and it can persist in the short-term".

Well, the VIX dropped to 30 early in the week before jumping back to 43 on Friday. The VIX won't tell us when the decline is over, but it will give some guidance as to when risk is subsiding. Alternatively, I think a push above the highs of August 8 could lead to another spike lower in the equity market, which would see the July 2010 low at 1011 tested relatively quickly. This would broadly equate with a re-test of the recent lows (3829) in the Australian market.

As for the US T-Bond/S&P500 ratio, it continues higher and is getting close to the highs of August 2010. My reading of this is that if the ratio pushes above those highs, then the possibility of a volatile reversal process (in the equity market) as we saw from July to September 2010, will be replaced by a sharper decline, which could last longer than many anticipate.

As it stands now, I think that although we could see a rebound sometime in Q4, upside potential is likely to be muted. As noted a few weeks ago, the head and shoulders top formation on the S&P is likely to mark a peak of medium-term significance (up to 12 months). And it could well mark a long-term top (1-2 years); under this scenario, the outlook for the Australian market will remain subdued.