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Simply, this should be a significant Selling opportunity

Lesley Beath  |  22 Nov 2011Text 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.

 

Reviewed this week

A selection of those facing significant resistance.

 

Please note: before making an investment decision, Morningstar recommends you read the fundamental research available on these stocks.

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

The Australian market continues to give a glimmer of hope, followed by periods of worry and concern - all of this within a range of a couple of hundred points.

As mentioned last week the All Ords still sits at the same level that it did back in mid October when it tested the downtrend from the April high. However it must be remembered that at the peak of the rally off the August lows (October 28), the All Ords had gained 17% so the recent pause was only to be expected.

But the action over the past couple of weeks, particularly last week, is now beginning to cast some doubt on the prospects for continued strength over the next few months. I said last week that many stocks in the Australian market had reached 'make or break' levels, and this was replicated in the US market where the S&P was stalling below the combined resistance of its 200DMA and the neckline of the Head and Shoulders top formation.

I thought that we would get a short-term pause, but I still leaned to a slight upward bias over the next couple of months.

I also thought that my mildly positive view would come under scrutiny in the short-term and that is exactly what is happening.

Let's examine why. Let's look at the facts and ignore opinion for a minute.

Firstly in the US, as mentioned, the S&P 500 rallied up to test its simple 200DMA in late October. In bear market rallies, price will often rally up to this moving average, and then retreat as the next phase of the bear unfolds. The 200DMA is monitored by Fundamental and Technical analysts alike. When an index or stock is trading above a rising 200DMA, the trend is assumed to be positive. When price breaks below the 200DMA the trend is turning. When the 200DMA is trending lower the primary trend is down.

The hardest task is to try and determine in advance when the average is about to change phase, remembering that there can be some powerful rallies while the 200DMA is still trending lower and some nasty declines while it is still headed north.

But at certain stages in the trend, price will test the 200DMA and then continue in its primary direction. In the current instance, the S&P 500 and indeed many individual Australian stocks are testing a flat-to-declining 200DMA. Simply, this should be a significant Selling opportunity.

Let's take a look at the last two bear markets in the US.

The S&P broke below the 200DMA in August 2007, but the break was quickly reversed, and new highs were registered in the October. Then the index began to decline again, penetrating the 200DMA in November. This was followed by a quick rebound but then the index began to decline in earnest. By January 2008 price was trading below the declining 200DMA. By March the decline amounted to 20% and then the rebound began. The index gained 15% by May, testing the declining 200DMA. It then came under pressure again and the rest is history.

 

S&P500 and 200DMA vs All Ords and 56DMA

(click image to enlarge)

 

In the 2000-2003 bear market the average had turned negative by October 2000, and there were five tests of the declining moving average over the course of the bear.