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Here's why the ASX could show further strength

Lesley Beath  |  14 Feb 2017Text size  Decrease  Increase  |  

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The Australian market is showing more upside potential than previously expected, technical analyst Lesley Beath says.

 

In the last report, I suggested the correction in the Australian market may have further to run. That still could be the case, over the medium term, but in the short term, last week's action was quite impressive, suggesting some continued strength in the short term.

There was a nice pop in the ASX REITs sector, which did not come as a great surprise as that potential was discussed in last week's report.

Also, there was some positive activity in the healthcare stocks, with the ASX Health Care Index breaking topside from the "flag" formation that was highlighted last week.

CSL Limited (ASX: CSL) also broke topside from its "pennant" formation, again discussed in the last report. Other components of the index appear constructive.

Cochlear Limited (ASX: COH) has pushed above its 200DMA and medium-term momentum indicators are positive. ResMed (ASX: RMD) had a strong week, up 4.6 per cent: action is encouraging but resistance just above current levels is significant.

Ramsay Healthcare (ASX: RHC), which declined by 22 per cent between September and the beginning of February, rebounded at the end of the week, and momentum indicators are improving from oversold levels.

Sigma Pharmaceuticals (ASX: SIP) has managed to hold above a critical support level.

All in all, the sector looks constructive.

As for the resource side of the market, the feature of the week was the topside break in the copper price. Friday's 4.3 per cent jump finally pushed prices above the November high.

It's a one-day move at the moment, so further strength is necessary to confirm the break. The surge was a result of the strike in BHP Billiton's (ASX: BHP) Escondida mine. Other base metals are not as constructive at this stage.

Brazil's Bovespa Index reversed the previous week's decline, pushing it back above resistance. A break above the late-January high at 6619 is required to confirm the breakout. Chile's Santiago IGPA Index closed the week at resistance.

So, resource markets are still emitting mixed signals. They are by no means suggesting a major pullback is imminent; the question is whether they can continue at the same pace as the last 12 months or so, and whether they will continue to outperform.

And on the subject of relative performance, I wanted to take a look at the smaller end of the Australian market.

As you will be aware, the ASX Small Ordinaries, outperformed significantly between August 2015 and August 2016. It then reversed and has since underperformed. But now, there are tentative signs that a reversal may be imminent.

Before we look at the relative-performance profile, let's discuss the action of the index itself.

The ASX Small Ordinaries Index broke out of a three-year range in May 2016. It then consolidated the break before pushing strongly higher into August.

The index then declined by 11 per cent and held above the support offered by the upper limits of the range. That support was also in the vicinity of the 200DMA.

The index bounced from that support and broke the August downtrend in early January. However, upside was short-lived and the Small Ords has since drifted lower. It is now edging higher again after pulling back to the downtrend. I am of the opinion the action is constructive.

Charts later in the report highlight this behaviour, so if you are getting lost with my description, just refer to those.

Now a look at the relative-performance profile.

The sector underperformed between February 2011 and July 2016. It then turned up. And it turned down again last August. These swings are par for the course.

I flagged the potential for the latest bout of underperformance last year, as the ratio began to roll over. Now, as the ratio bounces from the support of the early-2016 lows, it is worth monitoring closely for signs of reversal yet again.

Its early days so we need more confirmation but if the trend is in the process of reversing, even for the short to medium term, then some investors may wish to take advantage of it.

Let's step back and take a look at the ASX 200.

I said a few weeks ago that there was initial support on the index at 5611 and it held. But last week, I was concerned that momentum indicators were not encouraging and that the correction from the early-January high may have further to run.

However, last week saw some more positive developments, along with the constructive action in the ASX REITS and ASX Health Care the week prior.

In addition to those two sectors, the ASX 200 Industrials Index (the GICS sector, not to be confused with the top 200 industrial stocks) has bounced from its 2012 uptrend. The ASX Discretionary Index has also just bounced from a solid support level and the ASX Utilities Index has pushed through significant resistance.

Yes--as discusses in recent reports--the weekly "key reversal" is still intact on the ASX 100 Industrials index, but elsewhere there are signs of improvement.

As I said in the last report, we should "look at what is actually happening, instead of what you except to happen". And in that sense, I have to say the market is showing more upside potential than I expected.

As for the US equity market, there were no major developments. The Dow and the S&P continue to push higher while the Russell 2000 and the S&P Banks Index push against resistance. The VIX sits at the lower limits of its range, as it has done for the past couple of months.

The Chinese market had a solid week. The Shanghai 'B' Shares Index has rebounded from the critical support that was highlighted a couple of weeks ago. The Shanghai Composite is trading below the uptrend from the early 2016 lows, however, I think that overall the action is constructive. Continued upside is likely.

The Australian dollar was flat, stalling at the 2013 downtrend. Even if the dollar was to clear that downtrend there is strong lateral resistance associated with the 2016 high. A break above that area (77.64 to 78.20) is not envisaged at this stage.

The TWI (Trade Weighted Index) pushed marginally higher again and as mentioned last week it is has broken resistance and further gains are likely.

As with US dollar, the Australian dollar is pushing towards strong resistance on the euro. This has the potential to halt the advance, at least in the short term. So, the Australian dollar is coming up to an important level on the world's two major currencies--we will wait for it to show its hand.

 

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More from Morningstar

• ASX correction may have further to run

• Has the Australian market pullback ended?

 

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 have an interest in the securities disclosed in this report.

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