snippets - 23/10/09

This report is framed for conservative investors looking for the general market direction. Short term and day traders may find it useful for determining context for their trading.

MARKET SUMMARY

The general market (XAO) was in consolidation this week, range bound although it eked out a marginal move up of +0.35%. That’s the third week in a row the XAO has been in positive territory. Note – those figures are based on a Friday weekly close. The market this week was continuously below the bull rally high set, intra-day, on Thursday, 15 October at 4897.5. So on that basis the market was down marginally this week.

The XAO is above a rising 13-Day Exponential Moving Average. Seven out of ten SP Industry Sectors were up. For a change, Telecommunications was up. The best performer was Consumer Staples after Wesfarmers had a stellar run.

Best Three Sectors:

Consumer Staples: +2.61%
Telecommunications: +2.06%
Materials: +1.66%

Worst Three:

Financials: -0.37%
Energy: -1.63%
Information Technology: -3.47%

Risk Aversion is clear with two defensive sectors at the top of the list and Financials, previously the market leader, coming in the lowest band.

Among the sub-sectors: Property Trusts down, -0.99%; Metals and Mining, +1.91%; 50 Leaders, +0.52%; and Small Ordinaries, +0.65%. The 50 Leaders was marginally better than both the XAO but fell just behind the Small Ordinaries. Risk Aversion/Risk Inclination was evenly balanced according to these measures. Gold Miners relatively flat at +0.35%.

Chart One – Weekly % Change – Indices




XAO (All Ordinaries), XUJ (Utilities), XTJ (Telecommunications), XSO (Small Ordinaries), XPJ (Property Trusts), XMJ (Materials), XMM (Metals and Miners), XIJ (Information Technology), XNJ (Industrials), XHJ (Health), XGD (Gold Miners), XXJ (Financials less Property Trusts), XFJ (Financials including Property Trusts), XEJ (Energy), XSJ (Consumer Staples), XDJ (Consumer Discretionary), XFL (Fifty Leaders)

LEADING INDICATORS

Following are graphs for the two leading indices that I follow: Shanghai Stock Exchange Index and 10-Year Bond Yields (TNX – American Bonds). Both did well this week breaking above 65D-SMAs and could be on the verge of breaking their bearish stances. That now looks like the “line in the sand”.





VOLUME

Volume rose above the average on Thursday and Friday with Friday being well above the 2Billion shares traded. The significance of that is still to be determined. Whether that increase in volume was renewed buying leading to further rises, or selling by strong hands into weak hands ahead of further falls, is a moot question. Judging by the falls on the American market on Friday night accompanied by rising volume, the latter option looks like the best bet. We shall see. But that hasn’t changed the technical picture to any great degree. Volumes on the Australian market were good until a few weeks ago. Recently, however, volumes have not been supportive of the recent rise in the Australian markets. But our market rose anyway. Rising markets with falling volumes are usually weak markets leading to a move down. But the American market has continued upwards for months on falling volumes. This is the conundrum of the present situation

Following is a chart of daily volumes since before Christmas. Various seasonal patterns are evident in the volume figures. Naturally, with many people on holiday, volume drops off over Xmas and New Year. No great significance should be attached to that. Also, every three months, volume spikes with options expiries. Again, no great importance should be placed on those spikes. Recently, total volume spiked with a huge overseas cross-trade in GPT. Again – this has no significance. It is, however, important to note the trends clearly evident from the moving averages. To put the volume chart into perspective, here, firstly is a line chart over the same period for the XAO.

Chart Four – XAO (Line Chart)


Now, here’s the volume chart for the same period:



Since mid-August, while the stock market has been on a rip upwards, volumes have been steadily declining. We now have a clear divergence between the chart of the XAO and the On Balance Volume Chart. (On Balance Volume is a running total of volume calculated by adding the day's volume to a cumulative total when the price closes up, and subtracting the day's volume when the security's price closes down. It shows if volume is flowing into or out of a security. When the security closes higher than the previous close, all of the day's volume is considered "up" volume. When the security closes lower than the previous close, all of the day's volume is considered "down" volume.) This divergence between the XAO and the OBV suggests that there is now more selling pressure than buying pressure in the market.

Chart Six – On Balance Volume



Dr Alexander Elder has developed a more sophisticated use of the volume/price relationship. The Force Index relates the change in price to the change in volume by multiplying the change in price by the change in volume and plotting the result as a histogram. I’ve developed my own version of this, by plotting an 8-Day and 21-Day Moving Average of the histogram independently of the histogram. In interpreting this chart, the most important line is the 21-Day MA (shown in Red on the chart). When it is above Zero, the bulls are in charge, when below Zero, the market is bearish. Other factors are divergences and break of trend line when the trend has been in place for some considerable length of time. (The 8-Day Line has other uses, which I won’t go into at this time.)

Below is the 8/21 Sentiment Index.



This chart has fairly accurately defined the following:

1. The post-Xmas 2008 correction into early March.
2. Rally One from early March into June.
3. The June-July Correction
4. Rally Two from July to mid-October.

The current break of the up-trend line from July is an early warning sign of a correction. A break of the Zero line would confirm.

To Summarise: The current bullish posture of the market is not being confirmed by volume studies. This doesn’t mean that the market must fall here. The American market has had a bull run without confirmation from volume. But one must wonder how much longer the bullish stance can be sustained without sustained buying pressure to push it up.

SECTOR ANALYSIS

Following is the chart of Sector ratings. These ratings put most emphasis on major trends and less emphasis on recent market moves. Because of the emphasis on major trends, these tend to change with a glacial pace. But, if the Defensives flip into the positive half of the chart – this would have great significance for the return of the bear. This week two of the defensive sectors (Utilities and Consumer Staples) moved away from the -100 areas. But this is still not a significant move. With commodities on a tear (copper hit a 13 month high), the relativities between the Miners and the Banking sectors have begun to change. Financials down a bit, Miners up a bit. The significant move during the past three weeks has been the change in the Materials/Consumer Staples ranking. Three weeks ago, this was in danger of flipping into the negative band – but the bullish bias in the miners over the past three weeks has lifted this well into the positive band. This is significant because this acts as a proxy for the growth/defensive sentiment in the market.



Here’s how the 10 S&P Industry Sectors fared, ranked from top to bottom for the past week. The ratings are in order of magnitude with the previous week’s ratings in brackets. It may be significant that no sector gained a rating of +100 this week. Just a small nod in the direction of a market break down. Financials have been the market leaders for some weeks, but are now beginning to weaken just a little. Strength in the Materials is beginning to appear (XMJ:XSJ), although their market rating this week was static. Some of the defensives (Utilities and Consumer Staples) have improved a little. Some risk aversion is appearing.

S&P INDUSTRY RATINGS:

Financials: (+95), +90
Consumer Discretionary: (+90), +95
Industrials: (+80), +90
Information Technology: (+65), +20
Materials: (-90), -90
Consumer Staples: (-100), -90
Utilities: (-100), -95
Energy: (-100), -100
Health: (-100), -100
Telecommunications: (-100), -100

CURRENCY

This market won’t start to drop until we see the Ozzie Dollar start to weaken. While the Ozzie is strong, overseas money will flood into this country – liquidity is high and much of that is optimistically supporting the share market. This overseas money is speculative, “hot” money. Money which will be shifted quickly under adverse conditions. So don’t expect that to sustain our market in the future.

With the RBA Hawk (Glen Stevens) continuing to make loud noises about lifting interest rates, the Ozzie Dollar has consolidated its strong gains this week. With market chatter now favouring a 50 basis point rise in interest rates on Melbourne Cup Day, there seems little likelihood of the Ozzie falling. Overseas events may ameliorate any further significant advance. A surprise move, for instance, by the American Federal Reserve could put the cat amongst the pigeons. And, of course, a Black Swan event could see a move back into the American currency as a safe haven. Such events are, by definition, unpredictable; but when they occur too many people adopt the stunned mullet approach and do nothing – instead of acting immediately to protect their wealth.

This week the AUD/US$ remained stubbornly above 92 cents. While momentum seems to be slowing, the chart line is now above the top restraining line of the rising wedge. Careful watch should be kept on the Currency for any decisive break lower. Until it does – the share market will continue to rally. The following chart shows the Technical Analysis case for a move up close to parity.

Combine these thoughts with the analysis above on “volume” and perhaps we can see just how speculative recent action in our market has become. If I’m right about “hot” overseas money optimistically supporting this market, then the drop in volume since August becomes particularly ominous. It would seem that savvy Australian investors are cautious about this market, and any adverse news would see a very quick and dramatic drop in our market as the “hot” money looks for safe havens (usually gold and the American dollar).



INDICATORS

The All Ordinaries Index (XAO)
Short Term (Daily):

MACD: Negative. New Sell Signal.
Negative Divergence from chart price.

RSI: 63.69. Positive.
Negative Divergence from chart price.

Williams %r: -24.53. Positive

Chart price is still above the most recent uptrend line from July

Divergences are warning of a correction. For conservative investors, as long as the Daily MACD is above the Zero line and the Daily RSI remains above 50, this market remains a “buy and hold” market.

Chart TEN – XAO Daily




Long Term (Monthly):
MACD: Positive.
RSI: 54.7. Positive.
Williams %r: -4.27. Overbought.



To summarise: For the conservative long term investor, this is not a market to be buying into. Nor is it a market to be selling out of. But – it is stretched to the upside with serious divergences showing the possibility of a correction. Long term, the positive monthly MACD and RSI suggest that any correction should be perceived as an opportunity to add to holdings.

50 Leaders

Last week:
No. of Stocks above 10-Day SMA: 39 (78%)
No. Of Stocks above 50-Day SMA: 44 (88%).
No. Of Stocks above 150-Day SMA: 48 (96%).

This week:
No. of Stocks above 10-Day SMA: 30 (60%)
No. Of Stocks above 50-Day SMA: 43 (86%).
No. Of Stocks above 150-Day SMA: 48 (96%).

On Thursday, 15/10/09:
No. of Stocks above 10-Day SMA: 45 (90%)
No. Of Stocks above 50-Day SMA: 45 (90%).
No. Of Stocks above 150-Day SMA: 48 (96%).

The current figures are still too high. Expect a further pull back so that at least the 10-DSMA figure drops below 50. A drop down below 20 and a bounce would be healthy for the market.

ADVANCE AND DECLINE.

The Advance/Decline Line is continuing to show strength:



Momentum is, however, slowing. The 21-Day Average number of Advancing Issues is now below the 55-Day Average Number. Just another warning sign that the strength of this market is slowly weakening.



CONCLUSIONS

This week the market consolidated sideways from the previous week. The market, on the surface, is showing strength but internals, particularly divergent volume, absolute numbers of Advancing issues, and technical indicators are suggesting instability. The 50 Leaders eased the overbought situation this week – but there is still plenty of room for short-term downward movement. Although the market is showing fragility, the AUD remains strong and this should support further upward movement.

Any unexpected news or shocks could throw this market into a significant correction.

The reading for “Number of Stocks above the 150Day SMA” is extraordinarily strong and as long as it remains above 50% the bull market remains intact. This is supported by positive readings on the monthly RSI and MACD. Given these readings we must presume this bull rally is intact, albeit prone to sudden corrections such as we saw recently. And then the bulls come roaring back. One day – they won’t – and we’ll be looking at a 10-20% decline.

I’m not on the side of the doom’n’gloomers predicting a catastrophic decline. This rally, on good volume, has been too strong to be predicting catastrophe. But – I think we must now expect a correction of some significance. It is a question of when, not if.

Cheers
Red