Rudi On Thursday

This story features BENDIGO & ADELAIDE BANK LIMITED, and other companies. For more info SHARE ANALYSIS: BEN

(This stort was originally published on Wednesday, 8 April 2009. It has now been republished to make it available to non-paying members at FNArena and readers elsewhere).

 

The coming weeks will be very important for the short and medium term outlook for share markets. In fact, while I was contemplating the importance of the weeks ahead earlier today, I came to realise that the Big Issue whether share markets may have found The Bottom in this downturn -yes or no- may well be resolved over the next three to seven weeks.

At the centre of the Big Question is whether financial markets have now sufficiently discounted a sombre outlook for global economies and corporate profits in the years ahead (note: I used “year” in multiple form). Those with a positive attitude will tell you this is now the case. Others will tell you the bulls are dreamin’, this is going to get a lot worse still.

Personally I’d be inclined to break the question down in two different parts. Four weeks ago the optimists might have been closer to the truth, but after a four week rally of close to 20% (in Australia) and well above 20% in various markets elsewhere (US and Emerging Markets) I’d be inclined to side with the bears. After all, I have been warning everyone (who cared to listen) that banking shares in Australia were getting expensive. I have noted that the past week in particular many an analysts and market strategist has backed me up in this view.

The banks, as the leaders in this rally, represent most of the rest of the market. Hence my conclusion: this market is no longer cheap. And that’s always a vulnerable position to enter a very dim looking results season.

Grossly taken there are two sides to this US (quarterly) results season (plus the banks here in Australia): there is on one side the Big Question what those reported results will actually look like, and there is on the other side the Big Question how we will respond to it. While question number one remains open, question number two is simply unpredictable. The present fragile state of investor optimism, however, does not fill me with a lot of confidence that markets can withstand a lot of bad news this time around.

To be very honest about it: I fear it might actually turn out the complete opposite in that if the coming weeks will deliver investors with too many reasons to sell, we might even start ignoring some of the good news again.

This is one of the reasons why April and May might turn out key months this year. Will corporate profits still beat analysts expectations to the downside? (The opening of the season by Alcoa certainly seems to suggest the answer is “yes”). And what will our collective response to further disappointments be?

Two weeks ago I made two important predictions: I said the rally would cease with the S&P/ASX200 index around the 3780 level (see Rudi On Thursday, 30 March 2009) plus I said the real test for investor optimism would come in April with more economic data releases and, of course, the aforementioned US quarterly reporting season.

As far as the first prediction goes, on Monday the index closed at 3756.60, and it has been pulling back ever since. As far as the second prediction goes, I think Friday’s US unemployment release and Alcoa’s report yesterday have already shown overall investor sentiment will be put to the test thoroughly in the weeks ahead. To add a little local flavour to the occasion: an unexpected large profit warning by Bendigo and Adelaide Bank ((BEN)) on Monday followed by another grand disappointment by Flightcentre ((FLT)) on Wednesday speak for themselves. These are not the types of companies comparable with Alcoa, but they equally set the tone on an Australian scale.

But even without these corporate disappointments, nobody should be suprised the March rally failed to extend much further into April. I had a growing feeling the market was finding the going tougher from the third week onwards, simply by observing price actions. Add on top of this the fact that banking shares were running into value limitations plus BHP Billiton ((BHP)) shares back at, and briefly above, the $34 price level and what everyone should have concluded is that investor sentiment had probably reached a new peak again.

Things always go too quickly too far in financial markets.

This observation was supported by the Investor Risk Appetite Index at Standard Chartered which hit a multi-year high on April 2, approaching the record peak from 13 November 2002. Today analysts at Standard Chartered concluded: “there are signs this [index] is peaking at extreme levels and may see downside consolidation”. I think it is fair to conclude this “downside consolidation” (don’t you love these alternative descriptions to state the obvious?) has begun right here, right now.

But wait, there is yet another -and potentially very important- twist to this story. As I discovered during my research today, it is not the fact that share markets are back in retreating mode that will make April and May so important this year. It is all about what happens next.

On Monday my Weekly Insights story revealed that often key reversal points for financial assets are being forewarned by so-called head-and-shoulders formations on price charts. For those who have not yet read my story: please do as I am not going to rehash the whole analysis all over again (see “One Signal Investors Should Never Ignore”, Weekly Insights, April 06, 2009).

I wrote on Monday that gold had now formed exactly such head-and-shoulders, and it had broken through the neckline, hence the medium term outlook for the precious metal should now be considered “everything else but positive”. Equally, various commodities and commodity indices have formed a head-and-shoulders upside down, signalling commodities may now have formed a bottom for this downturn.

I also reported Commonwealth Bank ((CBA)) shares too had formed such a reverse head-and-shoulders on price charts. This would suggest banking shares have seen their bottom, at least for the medium term.

Today, I discovered this may not necessarily be true, at least not for long. Charts for all other banks -Westpac ((WBC)), ANZ ((ANZ)) and National ((NAB))- seem to show one shoulder and one half head. This means that price action in the weeks ahead will determine whether an actual head-and-shoulders formation will be formed and completed, or not.

And just to make my observation even more important: many other price charts show exactly that same half-completed head-and-shoulders. The ASX200. The Dow Jones Industrials. The Hang Seng. The Nikkei225. The FTSE100. The German Dax. Copper and zinc. The Aussie dollar versus the greenback. BHP Billiton and Rio Tinto ((RIO)) – though admittedly, those two price charts are not as clear as the examples mentioned before them.

In essence, everything that has moved up strongly since early March and that can be considered a reflection of increased global investor risk appetite appears to be halfway in carving out a head-and-shoulders formation on price charts. This is why I believe the coming weeks will be key for the outlook of share markets and for everything linked to investor risk appetite.

Just so we all understand each other: if price actions for the assets and indices mentioned above do complete the head, form a second shoulder and then fall below the so-called neckline, don’t think twice, but take your money and run (or even better: go short if you know how).

In case you need anymore proof, here’s what StreetAuthority.com has to say about it:

“The Head and Shoulders pattern is a major reversal formation.Typically, it takes at least two to three months to complete — and sometimes much longer. When a stock breaks below the neckline, there is no longer any support and very rapid declines can occur, often on increasing volume.

“A confirmed head and shoulders formation offers an excellent shorting opportunity. On the other hand, it can also provide an early warning sign for those with long positions to sell quickly. Often, traders will mistakenly hold on in “hope” that the stock will bounce back. In many cases, though, they soon find out that hope is one of the most dangerous four letter words in a trader’s vocabulary.”

At the peak of the share market in late 2007 BHP shares had carved out such a head-and-shoulders formation. BHP shares did it again in mid-2008.

Keep in mind though there are four key elements that need to be confirmed: two shoulders and one head plus price action has to fall below the neckline (preferably on increasing volume). Thus far all we have to work with is one potential shoulder and possibly one half head. All it would take is another extension to the rally and all of a sudden those price charts might be starting to look a lot different.

At least you now know what to watch and what to look out for.

I’ll be watching too.

With these thoughts I leave you all this week.

Till next week!

Your editor,

Rudi Filapek-Vandyck
(as always firmly supported by Greg, Andrew, Chris, Joyce, Grahame, George and Pat)

P.S. I will give a live presentation of my latest analyses and insights into the outlook for share markets and global economies. As you’ve come to expect by now, the presentation will contain some surprising conclusions, some interesting suggestions and some questions others would rather not ask.

You too can be part of the live audience, meet some of the names behind the stories (Greg will be there too), and ask questions directly from the audience to myself and Greg on stage.

The live presentation will take place in Sydney, at the Citi Pacific Hotel, 169-179 Thomas Street, Haymarket on Tuesday, the 5th of May, between 7-9pm. Entry price on the day will be $25 per person.

Pre-sale tickets cost only $18 per person, but you’ll have to be quick because only a limited number of pre-sale tickets is available, and for a limited amount of time only. So don’t wait too long to reserve your spot.

To purchase your pre-sale ticket, click here (send us an email if you cannot process your payment via our secure online payment system).

See you at the Citi Pacific in May?

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