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Domestic market unlikely to surge to the upside

Lesley Beath  |  05 Jul 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

A selection from the Resource sector.

 

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 US market bounced impressively from its 200DMA last week, and closed higher by almost 6%. The bounce does not come as a real surprise as it was noted last week that "improvement in China, India, and Japan, could be a lead indicator, suggesting that we might not be too far away from a short-term low in the US, and also here in Australia".

The recent bounce has removed some short-term risk, but as I have noted in recent reports there is potential for another decline within the next month or so, with the likelihood that we will see a "period of extended volatile trading as we saw between last May and August."

I guess the big question now is what will change that view. What needs to happen to suggest that we have witnessed a medium-term low, which will result in a sustained upmove?

That's a hard one, and we can only be guided by events as they unfold - trying to second-guess the market is fraught with danger.

One thing that is likely to give some early indication is the action of the US T-Bond/S&P ratio. This has been reliable in the past and it has been discussed regularly. The ratio had been trending higher since April, suggesting that that risk in the equity market was increasing, but last week's decline is encouraging and it appears as though the ratio is headed toward the support of the February and April lows; this will probably coincide with the US equity market testing its May high, and if a topside break in the later combines with a break below support in the ratio, then it is likely that the June lows in global equity markets will be the lows for the year. Let's address that if it occurs.

Back to what is actually happening.

Apart from the strong price rises last week, momentum indicators were also encouraging. On the S&P 500, the 34-week stochastic bounced from the 'signal line', and in Australia, both the 13 and 34-week stochastics are on the verge of generating a new Buy signal.

The All Ords is now testing the downtrend from the April high, but both the Materials and the Financials have overcome this resistance level. And just as a weekly 'key reversal' on the All Ords in mid April signalled a medium-term top, last week's key reversal, although not quite as robust, could signal a medium-term low. However, if we look at the price action in some of the larger stocks, beyond the Resources and to a lesser degree the Financials, there is not, at this stage, anything to get too excited about. So I think that the domestic market is unlikely to surge to the upside, and the prospect for a volatile range-trading period is still the most likely scenario.

It should be remembered that there is a lot more to look at than just the isolated action in individual markets. We need to look at a number of factors, and adopt a broader approach. In that sense, what is happening in the bond, commodity, and currency markets is also important. And last week's action in these was interesting. What happened was that there was a move out of 'safe havens' such as the Swiss franc, gold and T-Bonds. So the 'risk-on' trade was back in favour.

Interestingly though, the CRB still appears vulnerable.

As noted in the last few reports, the CRB index is tracing out a potential top formation; this comes on the back of a decline in oil and the 'food' commodities. The index managed to bounce last week, keeping support intact, but the price action is not, at this stage, all that constructive. The CRB is still at risk of a downside break.