Here's why the post-election rally can continue
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While caution is warranted, the topside break in the Dow Transports bodes well for the future performance of the US market, technical analyst Lesley Beath says.
Investors can be strange animals. The US market jumped when the FBI cleared Hillary of any misconduct early last week.
It then tumbled when it was thought that Trump was gaining in the election count. But after he made his acceptance speech, the markets soared.
We expected volatility and we got it. But at the end of last week, the S&P 500 was still basically trading within the sideways range that has been in place since July.
I said last week that "we have the situation where the S&P 500 is on its 200DMA and sentiment indicators are approaching fear levels. That combination can mean a buying opportunity is approaching, but with the US election this week, volatility, rather than opportunity seems likely".
Short-term risk was to the downside, but there was no evidence a major trend change was likely.
So, we have had the volatility; and opportunity, for those quick enough to act. What now?
Despite the fact the S&P 500 remains in a range, there were some very positive developments elsewhere. Most notably--and this is important--the Dow Transport Index broke topside last week.
The index had been butting against resistance for several months, and I have been of the belief that until that resistance was overcome, any meaningful upside in the US market was unlikely.
This break of resistance suggests the post-election rally can continue. Sure, it was Trump's focus on infrastructure that pushed the index higher, and Trump's victory speech was light on detail as to how this would happen, but nonetheless the break in the Transport Index is positive.
The S&P Banks Index was also a star performer, rising 13 per cent. You may remember this index had been trending higher, as the S&P had been coming under pressure. The index had broken above both its 2015 downtrend and its 200DMA back in August, and thus its profile had been positive.
I have often commented on the divergent behaviour of the main US indices, suggesting that because of that, we were not getting any clear signals. We are still seeing that divergent behaviour--with the action in the S&P 500 and the Nasdaq at odds with the strong showing in the Dow Transports and the banks.
But a look at the weekly chart of the S&P Banks Index shows strong resistance at current levels. What are the main takeaways from last week's action?
In my opinion it would have to be the topside break in the Dow Transports. For me, that changed the landscape more than anything else. It bodes well for future performance of the US market.
But in the near term, caution is warranted as the S&P and the Nasdaq remain below resistance.
In European markets, the action was less dynamic, and the resistance that we have been monitoring on the UK FTSE and the German DAX is still intact. The Japanese Nikkei also remains below its key resistance.
At this stage, until these barriers can be overcome, there is nothing to suggest a strong move in either direction.
As for the Australian market, it was good to see the ASX 20 Leaders bounce off the support I mentioned in the last report.
If you remember, I noted there was no obvious support on either the All Ords or the ASX 200, but there was significant and well-defined support on the ASX 20 Leaders. I noted "as I am of the opinion the 20 Leaders can outperform over the medium term, action in that index is important".
The ASX Small Ordinaries was also in the vicinity of a cluster of significant support. That also held.
The bounce from support is positive and it bodes well for the next few months, but there is hefty resistance at varying levels, so we may just see a gradual increase rather than a major move to the upside.
The ASX Banks Index posted a 6.7 per cent gain, taking it back to the upper limits of the range that has been in place for most of the year. A topside break would be the catalyst to push the All Ords above its key barriers. Until that happens, I don't think there is any need for major optimism.
I have been talking about the outperformance of the ASX 20 Leaders for several months now, and last week's action gave the ASX 20 Leaders/All Ords ratio a good boost. I see nothing to suggest the trend of outperformance will end any time soon.
But it wasn't all sectors that benefited last week--the yield plays (ex the banks) were hit hard again. They have been suffering for months now, and I have highlighted the situation on numerous occasions. I expect no major change in the near future.
There were big moves in the US T-Bond and the commodity markets.
The former failed to hold above the support that has been discussed in recent reports. I had thought there might be a chance of a short-term counter-trend move as the election approached, but that didn't happen.
The break below support was swift and decisive. Bonds have been in a bear market since July and there is no reason to believe it won't continue.
Copper broke out of its 2016 range, adding 10 per cent on the week. The rise over the past couple of weeks took copper to test its 2011 downtrend. The intra-day high on Friday pushed above the downtrend but it could not maintain the break.
Copper actually closed lower on Friday after a huge spike early in the day. It now sits on the trendline. Aluminium is in a similar position.
Iron ore jumped 23 per cent on the week--it too is facing the 2011 downtrend.
Given the extent of the gains last week, and the formidable resistance, a topside break, in the immediate term would be a hard task.
As for the major resource stocks, at first glance they continue to look robust ... but there are a few cautionary flags.
Brazil's Vale, which we have looked at time and again, added another 16 per cent last week, taking the rise over the past two months to 87 per cent. However, the stock has reached the initial target of $26 that I mentioned a few weeks ago. And with a daily "key reversal" last Friday, this could well be a short-term top.
Freeport McMoran hit strong resistance last week, but could not break topside.
In addition, the main indices in Brazil and Chile depict an overbought and high-risk situation. The former posted a weekly "key reversal" the week before last and followed that with a 4 per cent decline last week. The index has dropped almost 9 per cent since it peaked at the end of October.
But, and I might be too cautious, with copper and iron ore at a key barrier and with the oil price still rangebound, caution is warranted.
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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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