Inside the market

Cyclicals recovering ground

The All Ordinaries index was up 1.5% for the week, ending 22 February 2019. The index ended the week 2.3% above its 200 DMA and is showing considerable strength following a minor test of the 200 DMA in early February.

Of the 470 stocks currently comprising the index (and for which we collect data), 269 of these (57%) ended the week above their respective 100 DMAs, up from 260 (55%) names at the end of last week.  Two hundred fifty-six stocks were up for the week, while 214 ended the week flat or down. Two hundred and sixteen shares finished the week within 20% of their 52-week highs, with 79 of those within 5% of highs.

The stand-out sectors last week were the Financials and the Consumer Discretionary sectors, both critical leading indicators of the cyclical health of the economy.

The big banks, including CBA and NAB, attempted to rally and hold above their lows established in February 2016. Both stocks have managed to do so for the time being, and it is crucial that they continue to do so.

Commonwealth Bank (CBA)

CBA managed to break above the resistance level of the down trending channel that it has been travelling since May 2017. We are now looking for further evidence of the timing and direction of the next move. Either CBA is establishing a temporary bottom and will begin to trade within a new range, or if this rally fails, it means a continuation of the distribution. In this case, the last few months will prove to have been another test of the breakdown before further weakness unfolds.  

National Australia Bank (NAB)

NABs chart looks very similar to that of CBA. NAB is back into its trading range. However, it is currently unclear whether this will prove to be the last point of supply in an unfolding distribution or whether the support will hold and the stock will be able to establish itself back inside the trading range.

Westpac (WBC)

WBCs chart looks the worst of the big banks. The stock has been unable to recapture the lows of February 2016 since September 2018, and the stock is still in a downtrend.

Other important financial stocks that have been showing strength include ASX Limited (ASX), Macquarie Group (MQG) and Magellan Financial (MFG) who are all at or very close to new highs.

The Financials sector is enormously important as an indicator of the health of the economy, and it is essential that some of the heavyweights begin moving to new highs again.

Further, it is equally important that the big banks can hold their resistance levels and that we do not see any significant deterioration in their prices as this would spell trouble on the horizon.

ASX Limited (ASX)

Macquarie Group (MQG)

Magellan Financial (MFG)

Consumer Discretionary was the other sector that drove performance forward last week and that admittedly took us by surprise. In particular, Automotive Holdings (AHG), Lovisa (LOV), Wesfarmers (WES) and Accent Group (AX1), who each reported earnings during the week.

Each of these companies reported H1 2019 results that were better than expected by the market, which in a number of cases sparked a rally in the stock price that was able to take the stock out of a short term trading range established during the drawdown experienced by the market late last year.

Similar to the Financials industry, these signs of strength were constructive for what is a cyclical industry. It’s crucial now that these gains are consolidated. We wrote about most of these stocks in this post last week.  

Automotive Holdings (AHG)

With AHG we saw the selling climax in early December 2018 that was followed by a 2-month trading range with multiple tests of the support level established by the selling climax.

The stock displayed significant strength in pushing out above this trading range that was then followed by numerous backups into the former resistance line, and then finally a breakout accompanied by considerable volume.   

Lovisa (LOV)

We can see a similar pattern in the Lovisa chart. A selling climax at the end of October 2018 was followed by a 2-month trading range, which included a sharp decline on significant volume that penetrated the support level. The fall was followed by a quick recovery back into the trading range and a further test of the support.

The stock rallied sharply following the test of the shakeout on above-average volume and showed significant strength in moving to the top of the trading range. There was some further backing up action at the resistance level, which appears to have represented the last point of supply before the stock broke sharply out of the trading range.      

Wesfarmers (WES)

A narrow trading range characterised by numerous tests of support followed Wesfarmers selling climax in November. There was a final break above resistance and a number of further points of supply where the stock seemed to bounce around on top of the former resistance line. The stock finally showed its character with a strong breakout on heavy volume upon the release of their H1 2019 earnings.

Accent Group (AX1)

Accent Group is another former leader that suffered during the brief market meltdown late last year. The stock had been in a trading range since early 2018, however, fell sharply through its support level in October last year.

This support level then seemed to act as resistance as the stock tested this level numerous times in November and December and then once more in February. Following this final test in February, Accent broke back above the resistance/ support level on substantial volume, and back into the trading range.

Looking ahead

The Financials and Consumer Discretionary sectors are crucial in providing us with clues as to the direction of the overall economy. As we’ve said before, the stock market is an important leading indicator of the course of the economy.  Moreover, the relative strength of the cyclical sectors versus the defensives can provide further constructive feedback as to where the economy might be heading.

The strength we have seen in these sectors this year, along with some of the other cyclical industries gives us a sense that the economy might not be as bad as is being reflected in the media.

However, while bull market conditions make it easier for us to make money in the stock market, it’s not our job to try and forecast the future of the economy. Indeed, the best we can do as investors is to focus on the individual companies and groups of companies that are showing the most strength and avoid those that are showing weakness.

By Danny Sandler

Founder of Ocean Asset Management.