When we started writing last Friday’s Money Morning, the Australian stock market was down 20 points.
By the time you received it, the stock market was only down about five points.
By the end of the day, it had closed up 12 points.
We gave our market ‘barometer’ a tap to make sure it was still working. It had, after all assured us the stock market was set to slump.
We needn’t have worried.
In the US on Friday night, the S&P 500 index fell 1.66%, and this morning the Australian stock market looks set to open down 50 points.
This morning we consulted the ‘barometer’ again. It tells us there could be a storm on the way…
We remember our paternal grandparents had a barometer on the hallway wall. It had a dark timber frame that was just short of a metre tall and about 40 centimetres wide.
To be honest, we didn’t understand how it worked. We remember standing and watching it for minutes at a time. The needle never moved. It just kept saying the same thing.
Sometimes we get the same feeling with the stock market. We look at it every day. And every day for the past two months it has said pretty much the same thing — the market is fine; buy stocks while they’re cheap.
We knew that wouldn’t last. Because we know the stock market is fundamentally broken. Or rather, the economy is broken. It’s just that the stock market hasn’t figured that out yet.
But, with the stock market here and in the US now trading at a key level…and after Friday’s 200 point drop on the Dow Jones Industrial Average, perhaps the barometer has hit change…
Our old pal, Slipstream Trader Murray Dawes, certainly thinks it has. Here’s why…
Stock Market Instinct
Last week we explained why we knew the stock market was about to reverse. We didn’t base it on studying macro-economic data, studying company earnings reports, or analysing bond yields.
Instead, we knew the stock market was heading for trouble because on Thursday evening as we were about to leave the office, Murray looked like he was at the end of his tether.
That was all we needed to see to know that it wouldn’t be long before stocks copped a hiding. So we wrote to you about it last Friday.
Sure, it’s not the most scientific analysis you’ll ever read. But that’s the thing about the markets. It’s just as much about emotion as it is about lines on a chart or dollars in a balance sheet.
And the emotion is simple. An investor is always asking, ‘How will I make most money from investing?’
When the stock market is at its highest point in more than a year, it’s not unreasonable to wonder if stocks can keep going. After all, we’ve seen a 14% gain in five months, and an 11.2% gain since the start of the year.
To put that in context, the average annual stock market gain over the past 20 years is about 11%.
Because of that, active investors will weigh up the odds of more gains against the chances that the stock market will force investors to give up at least some of those gains.
And it’s that emotion that shows up in stock charts. Just as a cautious consumer can show up in a company’s profit and loss statement, as the company records fewer sales.
Stock Market Analyst Says ‘Watch Out Below’
So with all this in mind, this morning we asked the decidedly chipper Murray for his take on the stock market now. Here’s what he told us:
‘Friday night’s price action in the S+P 500 is exactly what I wanted to see. My view remains that the high from April this year of 1422 is a very clear line in the sand for the S+P 500. A failure below that level in coming days or weeks could ignite some very serious selling pressure. If you look at the chart you’ll see I have circled each time in the last few years that the 10 day exponential moving average has crossed below the 35 day simple moving average (My definition of the intermediate downtrend).Source: Slipstream Trader
‘It’s quite clear from the chart that this definition of the intermediate trend has given very timely warning that the momentum of the market was about to shift. If you combine the intermediate trend signal with the fact that a false break of the high from April this year is about to take place, then you get a very powerful combination that could see traders racing for the exits.
‘I particularly like the fact that the S+P 500 has bounced from the 1422 zone twice in the last few weeks. My feeling would be that the third retest of 1422 may not find the same level of support. I would not be surprised at all to see another bad down night in the States sometime this week (even in the next few days). Once the false break of April’s high is confirmed on a weekly chart then I would be targeting the 200 day moving average as the next line of support. That would take the S+P 500 to 1370. If the 200 day moving average doesn’t hold, then the downside target is another 100 points lower at 1270. In other words, watch out below.’
Murray isn’t the only stock market analyst ringing the warning bell. This morning, the Age reports:
‘Westpac and NAB have been downgraded by investment bank Goldman Sachs on concerns lower loan growth and a [sic] weaker margins would limit share price growth.
‘In the latest bearish signal for the banking sector, Goldman Sachs lowered its rating on Westpac from “neutral” to “sell” as the outlook for returns softens.’
And it’s not just here. US wealth managers are telling their clients to lock in gains now…
Selling Stocks to Avoid Tax
Bloomberg News reports:
‘An investor who sells $100 of stock with a cost basis of $20 in 2012 would see proceeds — after capital gains taxes — of $88, said Robert Barbetti, managing director and executive compensation specialist at J.P. Morgan Private Bank. Next year, if Congress doesn’t act, earnings from the sale would drop to $80.96 if rates rise to 23.8 percent. That means the stock price would need to rise at least 9 percent for an investor to be better off selling in 2013, said Barbetti, who is based in New York.’
The reason for the difference is that from the start of next year, tax rates in the US are set to rise on dividends and capital gains.
In other words, if US investors don’t think the stock market will go up at least 9%, then they’re better off selling now. And seeing as the US stock market has more than doubled since the 2009 low, the higher tax rates will mean millions of dollars in tax savings for the wealthiest investors who sell now.
In short, after a dream six-month run for stocks, the outlook doesn’t look so great. And if Murray’s analysis is up to its usual standard, you could be looking at a bumpy ride for stocks over the next few weeks.
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Written by Kris Sayce
Kris Sayce is Editor in Chief of Australia’s biggest circulation daily financial email — Money Morning. (You can subscribe to Money Morning for free here).
Kris is also editor of Australian Small-Cap Investigator, his small-cap stock research service, where he provides detailed analysis on some the brightest, smallest listed companies on the ASX.
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