This article appeared in the November 2013 ASX Investor Update email newsletter. To subscribe to this newsletter please register with the MyASX section or visit the About MyASX page for past editions and more details.
By Dale Gillham, Wealth Within
Regular readers of this newsletter will recall my article The best time to buy in 40 years in August 2012. At the time, many were sceptical of this "big call", especially given how the market was trading and the gloomy global news at the time, so I was excited when asked to review what I had written and update my view on the Australian market.
It is always hard to publicly predict the market because you cannot be 100 per cent accurate and you can become a hero or villain. It is important when reading my thoughts on where the market may go to be aware it is just a probability and as such, have a strategy in place. For an investor or trader, it is not so much a matter of whether the market goes up or down, but how you handle whatever occurs.
At the time of my article last year the market was literally trading sideways at around 4200 points, which is exactly where it had been in 2009, 2010 and 2011. Everyone, including fund managers, was sick and tired of what was going on, doom and gloom was certainly painted across the financial press and in investors' minds, everyone was in cash or transferring what they had into cash, and there was no real sign of things improving. In essence, the perfect set-up for a new bull run.
Chart 1 - All Ordinaries XAO 1 month bar chart - 1982 to 2014
At that point I really needed to make a call, quite simply because when people get sick and tired of being sick and tired, things start to move. Below is part of what I wrote.
"…When everyone is sick and tired of the market and the masses are exiting to cash, then I can assume pretty much that anyone who was going to sell has sold. With no one left to sell the market must rise.
"…From the low in 2009 there were two ways the market was likely to unfold. The best-case scenario said that the long-term low had occurred and that the market was likely to recover to around 5200 to 6000 points before continuing to rise back up towards the 2007 high.
"…So if I am correct, we are heading towards the best and lowest-risk buying opportunity in 40 years regardless of where the market heads from here, and I would suggest investors take some time to prepare themselves to enter the market again.
"…The challenge is that instead of embracing the opportunity, typically investors will wait until years into the bull market before moving away from secure cash-type investments, and in doing so miss out on the best and lowest-risk part of the bull run…"
Fast forward to the present. The All Ordinaries Index is trading around 5400 points for a gain of roughly 27 per cent at the time of writing. More importantly, the market has achieved this despite never-ending hiccups across the globe, including ever-present financial dramas in the European Union and the recent US Government shutdown.
The important question I am sure is on your lips is: where is our market going from here?
Where next for Australian shares
To move forward, it is often best practice to take a step back to fully understand where we have been and where we might go; the past tends to give a very good indication of the future. In analysing the All Ords, let's first look at the significance of the 5000-point level that you have heard much about in recent months.
Quite simply, 5000 points is a key psychological level. As humans, we tend to gravitate or pay additional attention to key whole numbers. The 5000-point mark is also very close to the 50 per cent mark (4962 points) of the distance in price that the market fell from the high in 2007 to the low in 2009 (see Chart 2 below).
Those with knowledge of legendary traders will know that W.D. Gann always discussed the importance of the 50 per cent level and it is something I constantly drill into my students. Specifically, Gann mentioned that failure to break strongly above this level indicates a weak market. As we know, our market failed many times to rise above this level during the past four years - and each time, this resistance zone became stronger.
Psychological levels have a tendency to act as magnets that prices gravitate towards. Traders and investors alike tend to have target levels placed with their brokers at these key levels. There are also breakout traders and investors who place new orders to buy just above these key levels. What often happens is that prices briefly break above core levels (such as 5000 points in the case of the All Ordinaries) by a small margin and deeply pull back from such levels if the rally fails.
Chart 2 below plainly shows the resistance zone (marked in green) forming between 2009 and the mid-point of 2013. Importantly, this resistance zone was, in my view, officially breached in the month of September. Although previous action did surpass the resistance zone, September provided the first, strong monthly close above the 5000-point area.
Even more importantly, this event tells me even greater highs are now on the cards.
Chart 2 - All Ordinaries XAO 1 month bar chart - 2007 to 2014
At the time of writing, October is looking bullish, with prices breaking above September's high of 5307.70, and it is important the All Ordinaries Index closes for the month above that level for me to maintain my bullish outlook. If so, there is high probability that the market will trade higher through to the end of 2013 and into early 2014.
My initial target for the All Ordinaries Index is around 5400 points, shown in Chart 3, which I have calculated using the same range in price (the high in 2007 to the low in 2009) that I used to determine the strength of the 5000-point level. 5400 points is represented by the 61.8 per cent price retracement of this price range - another key technical price point.
The use of past price movements is an excellent method to determine future movements, and is common in trading. I will also say that price is also often the most over-used method in trading, and this is why in my last article I used time as the measure to determine the future movement of our market.
Chart 3 - All Ordinaries XAO 1 month bar chart - 2007 to 2014
Using Chart 3 we can see that our next two target zones are around 5400 and 6000 points, and I would suggest our market is more likely to move closer to the latter before this current bull run ends. Using both time and price analysis, we can narrow down this target zone, and the chart shows we are now well and truly in the time area (the second blue shaded box) for our next major low, which is due before the end of next year.
We can narrow this area down in both time and price.
In Chart 4, below, I have used a simple price extension where I measured the range from the 2009 low to the 2011 high and then extended that range off the low in 2011. The chart shows the 100 per cent level is at 5849 points and is my next target level. We would expect prices to continue to rise to this level before experiencing any real resistance.
Chart 4 - All Ordinaries XAO 1 month bar chart - 2007 to 2014
Lack of space prevents me from breaking down my time analysis any further, but I will say that towards Christmas we can expect the market to continue to rise to the 5500 region. Over the medium term into February/March 2014, I believe it will move to around the 5800 level before falling away into our next major low due before the end of 2014.
Therefore investors need to be aware that the time to buy is running out and the need to reduce exposure to the market will occur by the end of the first quarter 2014, in my view.
There is higher probability that our market is long-term bullish and the low in 2014 will not be too extreme. That said, anything can happen in trading and there is still a possibility of a much larger fall back towards 2009 levels in the next year or so.
About the author
Dale Gillham is author of How to Beat the Managed Funds by 20%, and is Director/Chief Analyst of Wealth Within.
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