Listen To What April Has To Say

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This story was first published three days ago in the form of an email sent to paying members.

By Rudi Filapek-Vandyck, Editor FNArena

Sell in May and go away… we haven't heard that old share market “rule” being mentioned in a while, probably because it didn't exactly apply in 2009. My gut feel tells me, however, that we are about to hear the old May-rhyme making a comeback in 2010.

Only Blind Freddie would disagree that share markets are seemingly facing an increasingly tougher environment in the months ahead.

Sticking with the theme of seasonal trends, April doesn't often get a mention when it comes to forward looking market signals. Usually, it's all about December (Xmas rally), January (so goes January, so goes the year) and about the “evil twins” September and October who just happen to account for most sell-offs in history.

The validity and origin of the “sell in May” adage is dubious at best. When I conducted my own research in the matter, now four years ago, I could not find a clear conclusion in favour or against this supposed rule for the Australian share market, not even as a contrarian indicator, as suggested by some overseas experts at the time.

And as said earlier, investors who put the rule in to practice last year, would have missed out on most gains achieved by equities over the past 15 months. But this year is likely to turn out differently if the early signals provided by April are anything to go by.

As stated above, April usually doesn't receive a mention when it comes to seasonal trends and indicators. This is because April's signals are far less straightforward than the ones usually shown in the months mentioned earlier. This, however, does not mean investors shouldn't pay attention.

April often brings a reversal in trend, but its signals only become visible to those investors and market analysts prepared to spend that little extra time on that little extra detail. Last year, for example, gold formed a base in April which later on became the platform from which it rallied to US$1000/oz and beyond.

At the time, those with an eye for detail would have noticed that gold refused to return to January lows (higher lows in April), but also that gold completed a multi-month reverse head-and-shoulders formation on price charts during the month.

A head-and-shoulders formation looks exactly like what it says and is widely regarded by technical analysts as a strong signal that a trend reversal is about to take place. For a reverse formation: simply turn the figure on its head. Gold priced in USD fell from US$1000 in February 2008 to US$800 by year end. It formed a base around US$900 in April last year. By early December it peaked above US$1200/oz.

As such, it can be argued April signalled the downtrend for gold had come to an end. This year there's no such obvious technical signal to prove April's predictive powers, but many a chartist is nevertheless equally convinced that April has provided gold with the necessary building blocks to once again power higher later this year.

Note, for example, how gold has once again refused to return to lows seen earlier in the year.

Similarly, all market commentators, including myself, tend to refer to March as the month that started the global share market rally. Strictly taken this is correct, but all that happened in March 2009 was a short covering rally in US financials stocks. It was April that made the rally more than just that.

It would seem that April has been exceptionally busy this year, and not all signals are a de facto positive for equity markets. Below is a brief summation of some of the signals I spotted in April this year. Most implications do not require further explanation:

– It would appear the USD has now cemented its renewed uptrend against the Japanese yen and the euro. This could turn into a major negative for commodities.

– Talking about commodities… price charts for industrial metals suggest a peak in April for copper, nickel, aluminium and tin. In addition, various soft technical support levels have given in during the price correction over the past two weeks.

– Let's stay on the subject of commodities… Chinese traders put in selling orders when copper tried to surge above US$8000/tonne earlier in April, signalling a potential natural ceiling might be in place for the metal sometimes labelled “Dr Economy”. In addition, price premiums for Chinese contracts have all but disappeared (and the market focus, or so it seems, is once again returning to size and intentions of significant stockpiles in the country).

– The Shanghai share market has continued to show weakness and has now broken below what chartists viewed as solid long term support. The Brazilian stock market didn't wait long before doing the same.

– The Australian share market made a second attempt in April to conquer the 5000 level, but it failed, subsequently falling below technical support at 4800 instead.

– Many blue chip resources stocks are entering May trading below their 200 day moving averages. From an underlying trend perspective, this is not a positive. Stocks below longer term trend support include BHP Billiton ((BHP)), Rio Tinto ((RIO)), Fortescue ((FMG)), Woodside ((WPL)) and Santos ((STO)).

– Also note that for both energy stocks mentioned, the 60 day moving average is now below the 200 day moving average – hardly an endorsement of a healthy uptrend (despite crude oil prices having found a higher trading range in April).

– My personal favourite market indicator -consensus price targets and share prices for the Big Four banks in Australia- is signalling the Australian share market is increasingly running into valuation headwinds. This observation has been further strengthened by the fact that another solid result by ANZ Bank ((ANZ)) has left the consensus price target for the stock unchanged and even caused some minor cuts in future estimates by stockbroking analysts.

– As I pointed out in a previous market analysis, April marked the end of continuous upgrades to earnings forecasts for Australian companies. Most company reports issued during the month caused reductions to future earnings projections, including blue chips such as BHP Billiton, Rio Tinto, Woolworths ((WOW)) and CSL ((CSL))

– What the above observation implies is that, despite gi-gan-tic increases to bulk commodities prices, the positive impact from continuous upgrades to company earnings estimates has now disappeared, and sooner than many (including myself) would have anticipated.

– Chinese authorities have continued their focus on the speculative property bubble and their actions seem destined to cause a hard landing for property markets in China's big cities. While not expected to become a major factor for the Chinese economy as a whole, it is yet to be seen what impact this will have on the country's demand for resources, especially for those base materials with a strong link to construction activity (like: copper).

– International investors and the local resources industry are all up in arms about a proposed Resources Super Profit Tax. Viewed from a macro-view one would have to note two things: a) it would seem the extra tax will kick in from FY12 when, on current market forecasts, most resources companies profits have peaked and will be in decline; b) similar to RBA rate hikes, the Rudd government's extra tax on natural resources is likely the first signal of a new international trend – the Australian government is far from the only one in search of extra income for the coming years (and that's an understatement).

– US authorities seem serious about making Goldman Sachs pay for allegedly double-crossing naive customers. Again, from a macro-view, this can hardly come as a complete surprise and this too is likely to turn out to be only step one in a new international trend for stricter rules and regulations and harsher penalties for banks and financial institutions.

– From a trend line perspective, it can be argued the Australian share market has now fallen below a year long trendline that originates in July last year. Last time something similar happened, in January when the trendline that started in March 2009 was broken, a short but sharp sell-off followed between mid-January and mid-February.

– Similarly as in January, other equity indices across the globe are equally falling below trendlines.

– The Australian share market underperformed most international peers in April.

On top of all of the above, and this is equally important, April has also provided global investors with solid confirmation that the economic recovery in the US is more than simply a government stimulated mirage. Forward looking indicators are now signalling solid growth figures should be expected throughout Q2 and Q3.

Unfortunately, more confidence about the global economic outlook has coincided with worsening signals of sovereign debt problems in Europe that continue to put a question mark in front of the global outlook.

In summary, the combination of all of the above appears to point towards more weakness in the short term. On the other hand, expectations of much lower share market levels appear out of line with both share market valuations and economic developments.

To put it in to plain English: while it seems that further upside is limited right now, it equally appears there are limits to the potential downside. Unless, of course, those pesky sovereign debt problems turn into something more serious.

Assuming they do not, here's another saying investors may want to keep in mind: what doesn't kill you, makes you stronger. Given the improving economic fundamentals, there's a genuine chance this principle will apply to share markets too.

This story was originally written and published in the form of an email to paying subscribers on Monday, 03 May, 2010.

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