Here's why the US market could move significantly higher
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A break of the 2014 lows in the T-Bond/S&P 500 ratio could see the US market move significantly higher, technical analyst Lesley Beath says.
After the ups and downs associated with the US election, equity markets had a relatively quiet time last week. That "quiet" is good.
The S&P 500 still remains below its 2016 high, as does the Nasdaq. But encouragingly, the Dow Transport Index added to its recent gains. The action in this index continues to impress, and as I said last week, it bodes well for the US markets.
The S&P Banks Index jumped again, adding another 3.5 per cent. That pushed the index above the resistance of its 2015 high. The Russell 2000 also broke above its 2015 highs. The action is constructive and it does appear as though the US market can continue to move higher over the next few months.
I presented the chart of the US T-Bond/S&P 500 ratio in the previous report, noting the break of the 2015 uptrend. That is encouraging.
Remember that the uptrend, in favour of bonds, coincided with the loss of upward momentum in the equity market. The ratio has trended lower since early this year--but the resolution point was the longer-term trendline.
The recent break of that trend is very positive for the equity market: now all we need to see is a break of the 2014 lows. If that occurs, I believe the US market has the potential to move significantly higher.
Elsewhere, Japan's Nikkei added 3.4 per cent. The gain pushed the index through its key resistance. The break is marginal at this stage but I am impressed by the fact the Topix has finally cleared its 2015 downtrend.
This comes about as the yen continues to weaken against the US dollar. In fact, according to Bloomberg, it was the greenback's biggest two-week rally against the yen since 1988.
The US Dollar Index has pushed above the upper limits of the range that has been in place since March 2015. The US dollar has been appreciating for some time, so the recent strength does not come as a surprise.
I said back in September that "apart from anticipated strength against the euro, the US dollar appears to be preparing to move higher against the majority of currencies". A look at some of the currency charts later in the report highlights the extent of dollar strength in recent times.
If we look at the euro/US dollar (which dominates the US Dollar Index), it is now fractionally above its 2015 lows. So, it is holding support at this stage. But the US dollar is "on a tear" as they say. Emerging market currencies have been hit hard. At this stage, there is no evidence to suggest a reversal is imminent.
In that same September report I wrote, "the Australian dollar is not displaying any strong technical signs. It is still above its 200DMA but there is no sign of any significant move in either direction. But I believe that risk is to the downside".
It took a while, but the Aussie succumbed to downward pressure last week, dropping 2.7 per cent. The fall came after the currency approached its 2013 downtrend.
The technical position of the Australian dollar remains weak and further declines are likely. The monthly chart shows the lacklustre profile of the rally from the 2016 lows. Stepping back and taking an unbiased view of that chart, you could argue the 2016 advance was simply a countertrend rally within a long-term bear market.
Under that scenario, a re-test of the 2016 lows is probable, and a break below them a distinct possibility. We will just watch the situation as it unfolds--but risk is definitely to the downside.
Just as the Australian dollar was deflected from resistance, so was copper. If you remember, I noted last week that copper had broken above the 2011 downtrend on an intraday basis on the Friday; but it reversed sharply, ending the day lower. It closed the week on the downtrend.
Aluminium and iron ore were also facing the major downtrend. I said in the last report that "given the extent of the gains last week, and the formidable resistance, a topside break, in the immediate term would be a hard task".
Prices took the path of least resistance, closing lower last week. The pullback after the recent gains is not unusual, but the fact it has come as major resistance has been tested suggests caution is warranted.
And the fact the Australian dollar and some of the major resource stocks are also retreating from their key barriers, suggests this could be a medium-term peak.
Gold extended its losses last week, after declining sharply the week prior.
We last took an in-depth look at gold a little over a month ago, arguing that speculative long interest in the precious metal was extremely high, higher than it had been in 2011.
Gold's inability to advance at a normally seasonally strong time of the year was also a concern. Gold was still trading above its 200DMA but the uptrend from the 2016 low had already been violated.
I suggested at the time "it does appear as though further downside in the gold price is likely. The bulls need to be shaken out if there is to be a resumption of the uptrend ... of course, there are times when the speculative long interest is high and the gold price has still advanced, but we need to see some positive signs before assuming the worst is over for gold".
"The US dollar should, in my opinion, continue to strengthen and this is likely to continue to put downward pressure on gold".
I continue to believe the gold price can go lower. In the short term, there is support at $1199 (the May lows). That could stabilise price, but risk over the medium term is to the downside.
The Australian equity market stalled last week, consolidating the post-election gain, but action remains encouraging. However, there is a lot of overhead resistance, so gains may be muted.
The ASX Banks Index and the ASX Financial Index remain below the resistance that has been in place for months now. However, both held up well given that Australia & New Zealand Banking Group (ASX: ANZ) and Westpac Banking Group (ASX: WBC) traded ex-dividend through the week.
Among the other components of the ASX Financials, Macquarie Group (ASX: MQG) is pushing towards the highs of the past few years; Challenger Limited (ASX: CGF) remains robust; Magellan Financial Group (ASX: MFG) is bouncing from support, as is Suncorp Group (ASX: SUN).
All in all, the sector, despite the close proximity of resistance on the banks, appears constructive.
One sector which requires close monitoring in the near term is healthcare. The sector has been disappointing of late, with the major components falling sharply in recent months.
CSL (ASX: CSL) is still holding above an important support level, but it needs to spark up a bit. Ramsay Health Care (ASX: RHC) is sitting on its 200DMA, as is Cochlear (ASX: COH). These three are the main concerns at the moment. A quick reversal is needed to improve the profile.
What about the resource stocks? The majors are still holding up at this stage, although I do note that Rio Tinto (ASX: RIO) closed back below its 2011 downtrend last week. However, given the resistance on copper and iron ore, there is room for caution in the near term.
Some of the oversold industrial stocks appear less risky.
Use the links below to view the various chart packs.
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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 have an interest in the securities disclosed in this report.
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