This is why investors shouldn't be complacent
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With the US T-Bond/S&P 500 ratio testing support, investors should wait for confirmation before adopting a near-term bullish outlook on the equity market, technical analyst Lesley Beath says.
It was a "nice" week. The S&P 500 finally broke above resistance--following the breakout in the Dow Industrials, the Russell 2000 and the S&P Banks index a couple of weeks ago. Action is impressive.
It's been a good few weeks. Can it keep going?
I believe so, over the medium term. However, the US T-Bond/S&P 500 ratio is now testing the 2014 lows. As I mentioned in the last report, if that support is broken, then I believe US equities can move significantly higher.
But, given the importance of that support, I await confirmation before adopting a near-term bullish outlook on the equity market.
There are no signs of weakness at this stage, it's just that the market has seen some strong gains over the past few weeks, and with the "ratio" on support, this is not the time to be complacent.
As far as the major European equity markets are concerned, the UK FTSE has been unable to follow the US to new highs. The Frankfurt DAX and the Paris CAC remain below the highs of the past three months.
China is quietly pushing higher, in a structured fashion. No signs of reversal here at the moment.
And in the resource-based economies of Brazil and Chile, the major equity indices continue to flirt with strong resistance. They are proving to be resilient at these overextended levels--but in my view, it may be difficult to push appreciably higher in the near term.
In Australia, the All Ords added an impressive 2.6 per cent, buoyed by a 6.8 per cent advance in the ASX 100 Resources.
Base metals performed strongly. Copper and aluminium jumped, erasing the losses of the past week or so. Aluminium is back at its key resistance level. Copper has broken topside.
Iron ore did not follow base metals higher. It retreated over the week after hitting the 2011 downtrend two weeks ago.
The jump in the resource sector pushed Rio Tinto (ASX: RIO) above the 2011 downtrend. And in the US, Freeport McMoran pushed decisively above the major barrier that we have been monitoring.
When we looked at both charts last week, and the charts of copper, aluminium and iron ore, all were battling to overcome strong barriers.
I suggested that a cautious view was required. Last week's rally has clouded the situation, in that copper has broken out but iron ore has not. You cannot argue with the breakout in Rio or Freeport but they are overbought in the short term.
And while the action in the resource stocks continues to look strong, the resistance on iron ore should not be ignored. Of course, equities will often break above resistance ahead of the underlying commodity.
That possibility cannot be dismissed, but at this stage the cyclical downtrend in iron ore is still in force and until it is broken, some restraint is warranted.
The US dollar edged marginally higher on the week but it is beginning to lose upward momentum. Not surprising given the recent gains.
I noted last week that the euro/US dollar was still holding above support, despite the fact the US Dollar Index had conquered resistance the previous week. That support was tested on Wednesday and Thursday, and the euro managed to hold it.
In the near term, there is potential for some US dollar softness. It is not confirmed so let's wait and see what the next week brings.
The All Ords sits below the resistance of the 2016 peak, but the ASX 20 Leaders is now testing the early 2016 peak. That is an important barrier and with the major banks near resistance it may prove to be a difficult task to break topside.
The All Ords Accumulation Index closed last week just below its 2016 all-time high, so it is also facing a significant barrier.
Despite the resistance on the broader market indices, there are several sectors that look encouraging as they bounce from solid support levels.
They include the ASX Midcap 50, ASX Small Ordinaries, ASX Industrials, ASX Consumer Discretionary, ASX Utilities and ASX Transport. Charts presented later highlight the importance of support.
As regular readers will know I have spoken about the outperformance of the ASX 20 Leaders for some time now. And while I think that trend can continue, it could stall in the near term.
And that will probably be due to the banks. If we look at the ASX Banks/All Ords ratio, we see the banks have been outperforming since July/August. Now the ratio is facing the April 2015 downtrend. Given the banking stocks are also at resistance, a topside break is unlikely, in my opinion.
So we could see some of the smaller stocks and those from the Midcap 50 universe begin to outperform. In the latter, stocks such as Magellan Financial (ASX: MFG), Qube Logistics (ASX: QUB) and Fairfax Media (ASX: FXJ) have bounced from support, both in price and relative performance terms.
Both are in the vicinity of the 2012 uptrend. The downtrend from the August 2016 high is still intact at this stage, so it is premature to adopt a positive view. But they are certainly worth watching.
There's not much else to discuss this week. Let's keep a close eye on the support and resistance levels mentioned, and highlighted.
As I said last week, some of the sold- down industrial stocks are starting to show some improvement, whereas the banks may now struggle to overcome resistance.
As for the resource stocks, their chart action remains strong, but I am concerned the iron ore price is retreating from its 2011 downtrend.
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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