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Why it may be time to sit on the sidelines

Lesley Beath  |  04 Oct 2016Text size  Decrease  Increase  |  

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There hasn't been a lot of direction in markets over the past couple of months and investors may just have to get used to that, technical analyst Lesley Beath says.

 

There's not a huge amount to report on this week but let's jump in and see what is happening in the US and the major European markets.

The S&P 500 continues to trade in a relatively tight range. It remains above support and below resistance. Momentum indicators are neutral, giving no strong signals.

The US Banks Index and the Dow Transports are, in my opinion, the most interesting at this stage. The latter is once again testing its key barrier.

This is a significant level, which if overcome, would signal the potential for another up-leg. But at this stage the resistance is intact and we await some clarification.

The US Banks Index is at an important juncture. The index broke above its 2015 downtrend in late August but failed to gather any upside momentum.

It drifted back in September and is now testing the breakout level. It needs to recover quickly if it is to avoid a retreat back into the downtrend.

So we have both these indices at a potential turning point. And with the S&P below resistance we will just have to continue to sit and wait for a resolution.

We have to be patient--there hasn't been a lot of direction over the past couple of months, and we may just have to get used to that.

In Europe, both the German DAX and the French CAC broke above their 2015 downtrends a couple of months ago and they have also drifted back to test the breakout point. There are no strong signals, and certainly no dynamic action that inspires confidence.

The UK FTSE remains below resistance.

So, the overall picture in the US and Europe is one of indecision. The market is testing our patience, as it often likes to do.

As for the Australian equity market, the All Ords was flat on the week. It remains constructive.

The resource side of the market starred last week with a 1.8 per cent pop to the upside in the ASX Materials Index. The 2.8 per cent rise on Thursday pushed the index through resistance.

The ASX 100 Resources jumped 2.9 per cent, also pushing above resistance. Both breakouts are marginal at this stage and I don't consider them as confirmed breaks, but let's see what happens over the course of week.

The break, as you would imagine, coincided with a topside break in BHP Billiton (ASX: BHP). I said in last week's report that BHP might give early guidance for the broader market and I think that is still correct.

Last week's break above resistance is encouraging. However, Rio Tinto (ASX: RIO) has yet to overcome its barrier. I would like to see RIO follow BHP's breakout before assuming the longer-term outlook has turned clearly in favour of the resource sector.

It may take a bit longer to resolve but it is worth waiting. I still remember the early 2011 experience where BHP broke topside but RIO did not-- that non-confirmation marked the beginning of the bear market for resources.

Fortescue Metals (ASX: FMG) has been a standout performer and has significantly outperformed its peers since mid-2015. I believe that trend of outperformance has now come to an end.

The ASX Energy Index advanced 4.4 per cent last week, boosted by an 8 per cent rally in the oil price.

Woodside Petroleum (ASX: WPL) is interesting at current levels. The stock broke above its 2014 downtrend in mid-August but then drifted lower again, retreating into the downtrend.

But it did manage to stay above its 200DMA and last week's bounce has pushed it back above the downtrend.

Beach Energy (ASX: BPT) presents a very encouraging chart profile. It has just broken above the May downtrend and the break has been on strong volume.

The US Oil & Gas Index has also traded above its 200DMA for the past few months. This comes after the break of its 2014 downtrend back in May/June.

The index, like the ASX Energy Index, has not forged any topside breaks, but the action is constructive.

The oil price remains stuck between support and resistance as it has for some time now. Don't forget that the oil price rebounded from a major support level earlier this year and it has progressed in a constructive fashion.

Risk is to the upside and the chart pattern is encouraging. Near-term resistance is the early-June high at $51.61; if that can be overcome the next target is toward the $59-$61 level.

As regular readers will know, I have spent a lot of time on resource/industrial ratios over the past month or so, as I believed an inflection point was imminent.

In the last few weeks I have thought the pendulum might be about to swing away from the resource sector, but there has never been a definitive break above resistance. So, the jury has been out.

Last week, the ASX Financials/ASX Materials ratio broke marginally below support and the ASX Materials/All Ords ratio pushed above resistance. I don't think the break is valid at this stage, although I do think the price action in the resource stock looks robust.

On a different subject, I highlighted the ASX Consumer Staples index a few months ago noting the potential for outperformance.

Obviously, the biggest influences on the sector are Wesfarmers (ASX: WES) and Woolworths (ASX: WOW), and with Wesfarmers now facing the upper limits of its recent range, I thought we would take another look at the situation.

The ASX Consumer Staples/All Ords ratio rose between July and late August and then stabilised. It appears as though the recent action is a consolidation phase, and from a longer-term perspective, I believe the sector can continue to outperform.

As for Wesfarmers, it is unclear whether or not it has the capacity to break topside. The barriers are $44.60 and then the all-time high at $46.95. In the current environment, a topside break seems the least likely scenario.

Woolworths traded below a critical support earlier in the year and spent several months there. But there was no follow-through and price pushed back above that support in July. It then rallied strongly and when we reviewed the stock in August it was in an overbought position.

It promptly fell by 14 per cent, and has since stabilised in the vicinity of the 200DMA. It has worked off the overbought condition and risk is now to the upside.

The other stocks we looked at in August were Bega Cheese (ASX: BGA), Treasury Wine Estates (ASX: TWE), Metcash (ASX: MTS) and Blackmores (ASX: BKL).

Bega has continued to improve, albeit gradually. TWE was overbought at the time, but it has since worked off that situation. Metcash remains below its $2.28 resistance.

Blackmores showed signs of improvement a couple of weeks ago as it bounced from the lower limits of its trend channel, but it has not gained any upside momentum.

Until there is some positive price action, it is probably best to sit on the sidelines.

 

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More from Morningstar

• Why investors should look to BHP for market guidance

• Australian market action encouraging

 

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.

© 2016 Morningstar, Inc. All rights reserved. Neither Morningstar, its affiliates, nor the content providers guarantee the data or content contained herein to be accurate, complete or timely nor will they have any liability for its use or distribution. This information is to be used for personal, non-commercial purposes only. No reproduction is permitted without the prior written content of Morningstar. Any general advice or 'class service' have been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), or its Authorised Representatives, and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. Please refer to our Financial Services Guide (FSG) for more information at www.morningstar.com.au/s/fsg.pdf. Our publications, ratings and products should be viewed as an additional investment resource, not as your sole source of information. Past performance does not necessarily indicate a financial product's future performance. To obtain advice tailored to your situation, contact a licensed financial adviser. Some material is copyright and published under licence from ASX Operations Pty Ltd ACN 004 523 782 ("ASXO"). The article is current as at date of publication.