The All Ordinaries (XAO) was up about 6% this week recapturing all the losses of the week before. The big winners were the Resource Stocks and Financials (including Property Trusts which were up approximately 16% on the week). The losers on the week were Health, Telecommunications and Consumer Staples. The nature of these winners and losers will take on special significance when viewed in the context of further comments below.
GENERAL OBSERVATIONS
The Australian stock market this week had a big rise, regaining all of the previous week’s big drop. The question on everyone’s lips seems to be: Is this a dead cat bounce, the start of a bear market rally, or the beginning of a new bull market?
A cursory look at the XAO chart with trend lines might suggest that it is a dead cat bounce.
The Index has risen to the first level of horizontal resistance on the daily chart (closing basis). Above that are two down trend lines – one of medium term time the other of a longer term. The 34-Day Simple Moving Average is aligned currently with the medium term down trend line. The 150-Day Simple Moving Average is a little above and more or less parallel to the longer term down trend line. All of those represent strong resistance to further upward movement. The line of least resistance is down.
The Indicators (see below for more details), however, are suggesting the possibility of a sustainable rally. The Weekly MACD is positive, the Daily MACD is positive. A break above horizontal and vertical resistance (trend lines) still has to occur. The Daily Slow Stochastic is overbought, so some consolidation will probably occur before all the necessary conditions for a sustainable rally are confirmed.
A new bull market? It is far too early to say. But I think it is highly improbable. Bottoming processes in bear markets are usually drawn out affairs with at least one retest of the bear market low and sometimes more.
So it leaves us with the question: Is this just a dead cat bounce or a sustainable bear market rally?
To find out some more evidence on whether this rally is sustainable, I’ve been analysing the structural condition of the XAO with the use of ratio charts to see if money is being switched from defensive to more risk oriented positions. A sustainable rally is not possible unless investors are willing to embrace risk. The results are informative. (Note: Ratio charts show relative changes of one index to another. It does not provide absolute values. So a ratio chart could show an Index advancing relative to another Index while falling in absolute terms.)
Remember a couple of weeks ago, I said that the Utilities Sector (a defensive sector) was uncharacteristically the weakest sector amongst all the sectors making up the XAO.
The Utilities/XAO Ratio Chart has formed a large double top over approximately 100 days (about five months) and has now broken below the neckline of the double top. It has also fallen below the 150-Day Simple Moving Average.
Telecommunications shows a similar pattern.
The two other sectors usually associated with defensive plays are Health and Consumer Staples. Both of these have shown dramatic drops in relative value compared to the XAO while the XAO has been surging in the past week. Both have dropped below key relative support levels during the past week.
While Utilities and Telecommunications have been losing relative value, the benefactors of this shift have been the Resource Stocks. These stocks are associated with growth and risk, and are dependent to a large degree on events in China. The SSEC (Shanghai Stock Exchange Composite Index) has been in an uptrend since late October 08.
The Materials sector has also benefited from a flow from the Financials. The XLF/XAO ratio has been in a down trend for about five months. About the same length of time the Materials have been in a relative uptrend.
It is hard to conceive of a rally in the general market unless both Materials and Financials are rising. This may finally be occurring.
The Financials/XAO downtrend has taken the form of a bullish downward sloping wedge. The Financials/XAO RATIO surged this week and broke above the wedge after a false break below.
I could go on with further analysis, but that would probably only induce "paralysis by analysis" (if I haven’t done so already. ☺) I believe, however, that the above shows that conditions have set up nicely for a sustainable rally with investors willing leave behind defensive positions and to take on more risk than they have been in the recent past.
This doesn’t mean that the rally must occur. Another bombshell out of America would wreck any chance of that. But the probabilities of a good rally into May or June have certainly increased.
Don’t expect the uptrend to continue in the current week. We’ve come a long way in a short period of time. (The Banking Sector in the U.S. has risen 45% in the past week.) So it’s time for a breather, perhaps consolidation or some retreat. A break above short term resistance on the XAO/XJO would be a signal to enter long in this market.
MACD: positive. The MACD histogram has turned up this week suggesting further rises ahead. RSI: 36.5. The weekly RSI has bounced nicely off the 30 (oversold) level. A strong positive divergence has been set up on this indicator. Positive Slow Stochastic: 17.7 and below its signal line. Oversold. DMI: negative.
SHORT TERM (Daily):
MACD: Positive RSI: 50.9 and rising. Positive Slow Stochastic: 88.6 and rising. Overbought. Suggests consolidation or a mild retracement will occur DMI: negative. The ADX has changed direction suggesting a positive trend change.
Last week I said: "The picture provided by all these Indicators is dire. The only positive indicator is the Weekly MACD which is notorious for lagging the market. The picture is so bad, one must consider that a sizable bounce is due . . ."
Well, we got a good bounce. If we can now get a small retracement or consolidation, the context has been set up for a sustainable rally. But – don’t pre-empt the market.
50 LEADERS
No. of Stocks above 50-Day SMA: 19 (38%). No. of Stocks above 150-Day SMA: 3 (6%).
The number of stocks above the 50-Day SMA has increased from the oversold level of 20% to 38%. This is a bullish development.
Three stocks were positive on both readings: Newcrest Mining, AGL Energy, and Santos
CONCLUSIONS
The indicator readings on the Australian market suggest that a sustainable rally is possible. The XAO still needs to move decisively above short term resistance (horizontal and vertical) before a decision to invest should be made.
I’ve made a case today for an improving context for the taking on of risk. This is an essential for any sustainable rally.
If you do enter the market, I believe you should be prepared to exit when the indicators suggest a reversal in trend is taking place. This is still a bear market – a dangerous place to be for any investor.
Don’t enter until factors are in your favour – don’t pre-empt the market. Preservation of capital is the most important factor at this time.
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