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Resources still the favoured sector

Lesley Beath  |  06 Nov 2012Text 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.

 

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

Action in the US equity market continues to suggest that risk remains to the downside and this should continue to pressure our market.

The All Ords has retreated over the past couple of weeks, and as noted last week, I believe a test of the 200DMA, which sits about 4 per cent below current levels, is likely in the near term.

The medium-term outlook will be dependent on whether or not that support holds. At this stage I believe that it will, and if China continues to improve as the technicals suggest it will, then the resource side of our market is likely to outperform.

This potential for outperformance in the resource sector has been discussed over the past month or so, and although the turn in relative performance is taking its time to unfold, I remain of the opinion that an overweight stance is justified, not just against the broader market, but also against the banking sector.

Of course the yield on the banks is superior, but even taking the yield into account, by comparing the ASX Banks Accumulation Index to the ASX Materials Accumulation Index, there is still evidence to suggest that the latter is poised to outperform.

Obviously, the accumulation indices do not reflect franking credits, so that is not taken into account, but the key point is that the larger resource stocks, after underperforming since July 2011, now have the capacity to outperform.

They offer less risk that the financials, and although they may continue to trade in base formations, which can be volatile, they are, from a medium-term perspective, exhibiting an improving profile.

This potential for outperformance, as mentioned above, coincides with an improvement in the Chinese market. The latter was highlighted in early October as the Shanghai A Shares Index registered a weekly "key reversal" as it bounced from the lower limits of the trend channel that has been in existence since 2009.

The index is improving, albeit slowly, and it does appear as though a medium-term low has been registered. This comes after a three-year bear market and a 42 per cent decline.

To digress briefly, a quick review of the ETF (exchange-traded fund) iShares FTSE China 25 (IZZ) highlights a strong performance over the past couple of months.

The index is fast approaching resistance in the form of the February 2012 high - a break above there would complete a year-long base formation. This would be a positive development, and as it coincides with an improvement in the Shanghai market, it is another factor suggesting that risk in China is reverting to the upside.

The ETF, according to the iShares website, consists of the largest and most liquid Chinese companies, and "seeks investment results that correspond generally to the price and yield performance, before fees and expenses, of the FTSE China 25 Index".

It is "designed to represent the performance of the largest companies in the China equity market that are available to international investors". It is priced in Australian dollars, so the currency will have an impact on performance.