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Why this could be the calm before the US market storm

Lesley Beath  |  29 Aug 2016Text size  Decrease  Increase  |  

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A lack of action on the US equity market is disconcerting and there are signs to suggest caution is warranted, technical analyst Lesley Beath says.

 

It was another week of quiet action in the US equity market. This has been an ongoing theme for a while now and it is somewhat disconcerting. It feels like the calm before the storm, so to speak.

I can't really see any major sell signals on the US market but there are a few signs to suggest caution is warranted. The VIX is now edging higher after spending the past month or so at the lower limits of its recent range.

And the weekly stochastic indicator on both the S&P 500 and the Dow Industrials is beginning to deteriorate from overbought levels.

The Dow Transport Index continues to trade below its key resistance and the Dow Utilities has been retreating from the upper limits of its major trend channel for the past month or so.

So, the three Dow indices are suggesting risk has moved to the downside.

Interestingly, the US S&P Banks Index rose last week, pushing marginally above the downtrend which we have been monitoring. There is lateral resistance at current levels so that could be a stumbling block. I don't think the break is robust at this stage.

This potential deterioration in the US indices comes ahead of the seasonally weak September/October timeframe.

I always get concerned when equity markets approach these months from an overbought or vulnerable position.

September is actually the worst-performing month of the year for the S&P 500, and October can be nasty.

I am always conscious of this seasonality, but as always we need to focus on what is actually happening, as opposed to what "should or could" happen.

If the US equity was presenting a more robust technical structure I would be less concerned about the weak seasonals, but given the recent action, I feel it is wise to adopt a cautious approach.

If we look at other global markets they exhibit a mixed profile. On the positive side, the German DAX is still holding on to its recent break of the 2015 downtrend.

At this stage, European markets do not appear as vulnerable as the US, but they are unlikely to push significantly higher if the US comes under any pressure.

As for the Australian market, risk remains to the downside, with the All Ords unable to break above resistance. Until that resistance can be overcome, a cautious approach is warranted, especially in regard to the banks.

One of the important things to watch in the short term is the ratio charts I highlighted last week-- those relating to the resource side of our market.

As you know, resources have outperformed since the beginning of the year, but the ratio charts that I featured last week depicted strong and important resistance at then-current levels.

The resource side of the market underperformed last week, keeping those resistance levels in place. I will present the charts later and you will see the key levels to monitor.

The ASX Small Resources and the ASX Midcap Resources have been standout performers this year, rising by 57 and 67 per cent, respectively. And while the Midcap Resources hit new 2016 highs last week, the Small Resources has been unable to overtake its July high.

In looking at both ratios compared to their industrials counterparts, while no major support levels have been breached, I think risk is shifting in favour of the industrials.

It is too early to make a definitive call on that at the moment, but given most of the relevant ratio charts are in a similar position, this is a critical time.

This comes at a time when copper and nickel are retreating--and gold is unable to push above its key barrier.

I think the odds favour a reversal of fortune for the resource side of the market.

So, if the resource side of the market could retreat in relative performance terms, which sectors might benefit?

Consumer Staples? I think so, so let's spend some time on that.

If we view the chart of the ASX Consumer Staples/All Ords ratio, we see it trended lower in a steady fashion between 2013 and 2015.

The ratio shot up in the second half of 2015 and early 2016, but those gains were subsequently erased. The ratio bounced from support in late July and has since risen impressively.

Obviously, the key drivers of any outperformance will be the heavyweights Wesfarmers (ASX: WES) and Woolworths (ASX: WOW).

The latter was the main driver of underperformance by the Consumer Staples Index, as it almost halved in value between May 2014 and July 2016.

The stock has rebounded impressively since the July low, and importantly, it has pushed back above critical long-term support.

That support, which embraces the July 2008 and November 2011 lows, was breached earlier this year but there was no follow-through and it has now been reclaimed.

Woolworths is overbought in the short term but it does appear as though it has finally turned the corner.

Wesfarmers has basically traded in a broad sideways range since early 2013. It is now approaching the upper limits of that range: although it should be noted that the all-time high in February ($46.95) sits just outside the range.

A topside break is not indicated at this time, but the stock is likely to continue to outperform the broader market.

If we take the ratio of Wesfarmers/Woolworths, you will see the 2014 uptrend has just been violated.

The break is marginal at this stage, so I would be watching for further deterioration before assuming the trend has changed in favour of Woolworths.

I checked on other stocks in the ASX Consumer Staples Index to see if there were any opportunities there. There weren't any low-risk situations, in my opinion.

The closest would be Bega Cheese (ASX: BGA), which has pushed higher over the past month or so after bouncing from good support.

Treasury Wine Estates (ASX: TWE) continues to surge, but is it overbought in the short term.

Metcash (ASX: MTS) has been a steady performer--a break above the recent high at $2.28 would suggest continued upside.

The stock with the biggest question mark over it is probably Blackmores (ASX: BKL). The former market darling has given up almost 50 per cent of the gains it achieved between late 2013 and early 2016.

We looked at it last week when we discussed the 200DMA. Blackmores was trading below its 200DMA and that was going to act as a significant resistance.

The decline from that moving average doesn't surprise, although the severity of it does. There is an unfulfilled downside target on Blackmores of $120.38, so there is scope for a little more pain. The stock needs to show some improvement in price to suggest the worst is behind it.

So where does that leave us? Yes, I think the Consumer Staples Index can outperform, but at this stage it is likely to be by default.

There are no standout opportunities. This is another reflection on the near-term prospects for the broader market.

 

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More from Morningstar

• Here's why resources could continue to outperform

• Aussie market hits brick wall

 

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.