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Look to Shanghai, not Dow
This article appeared in the July 2011 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.
What the charts say for sharemarkets in Australia, China, US and London.
By Daryl Guppy, author
Twelve months is a long time in the sharemarket, especially when increased volatility provides a constant background. Recently I spoke alongside the prominent economist Nouriel Roubini at a Global Investor Forum in Singapore, where he provided three scenarios for 2012: stalled growth, very slow growth, or a faster recovery. But he counterbalanced these with half a dozen bearish factors.
Traders and investors do not have the luxury of academic economists, so the analysis below focuses on identifying key trigger points in key charts for the Australian, Chinese, United States and London sharemarkets. These are the levels, or behaviours, that indicate a significant trend change is developing, or an alternation in the behaviour of the market. We cannot know which of these will develop, but recognising the signals early prepares us to quickly take the necessary action.
There are two features to recognise on the S&P/ASX 200 chart below. The first is that the market has moved in a broad sideways trading band starting in January 2010. Investors who bought at that time near 4900 have endured losses of up to 14 per cent and seen essentially no upside. This is not to say you cannot make money with individual shares, but it is far more difficult than in markets where there is a strong underlying secular uptrend.
The trading band stretches between 4200 and 4950 and is bisected by a support level near 4500. For much of the past 18 months the market has stayed in the upper half of the trading band. This band structure provides two sets of upside and downside targets, calculated by measuring the width of the trading band. An upside breakout above 4950 has an initial target near 5400. This is the width of the upper section of the trading band projected upwards. The long-term upside target is near 5700. This is calculated by taking the full width of the trading band and projecting this upwards.
S&P/ASX 200 weekly chart
The support level near 4500 is the middle section of the broad trading band. The market may continue a sideways movement in the lower section between 4200 and 4500. This is not a change of trend but a continuation of the broad sideways pattern of behaviour that has prevailed in the past 18 months.
A fall below 4200 has two targets. The short-term target is near 3760. The larger target, calculated from the full width of the trading band, is near 3490. Both targets match historical support and resistance levels created in late 2008 and early 2009.
The second feature is the change in relationships between the Australian index and world markets. The behaviour of ours more closely mirrors the behaviour of the Shanghai index than the Dow Jones index in the US. People who look to the Dow for market leadership are looking in the wrong direction.
The behavioural pattern of the Shanghai index is a replica of the behaviour of the S&P/ASX 200 index, but it leads by several weeks. Our index still has a knee-jerk reaction to US market behaviour, but also the long-term influence in China.
The Shanghai index has less downside potential than S&P/ASX 200 index. The trading behaviour is broader, stretching between 2350 and 3300. The trading band has a wide middle consolidation band between 2700 and 3000. When this middle band is projected upwards or downwards, it gives the upper and lower limits of the broad trading band between 2350 and 3300. Trading band analysis is more appropriate than trending analysis, although strong trends within the broad band will generate 40 per cent returns.
The downside for the Shanghai index is constrained by the strong historical support level created by the 2008 lows near 1800. The behaviour of the market suggests the 2350 support level is strong.
Shanghai index weekly chart
The Shanghai index has three upside targets, the first near 3620. This is calculated by taking the width of the upper edge of the trading band and projecting upwards. The second target is near 3920 and is double the width of the first trading band projection. The third target is near 4300, calculated from the full width of the trading band.
Moves above 3000 towards these targets may be characterised by strong trending activity with consolidation near each of the target projection levels. This pattern of rally or retreat and consolidation is a behavioural feature of the Shanghai index. On balance, we retain a bullish outlook for the Shanghai index, with strong trend moves of up to 40 per cent within the broad trading band.
The S&P 500 index's retreat from 1360 is a reaction away from the support level that created the base of the rounding-top pattern that preceded the S&P market collapse in early 2008. The S&P behaviour is defined by these long-term support and resistance levels. The S&P has created an inverted head-and-shoulder pattern between December 2008 and March 2009. The upside target projection for this pattern is near 1260 and this was achieved in December 2010. The S&P broke above this level, moving to 1360. In the process it tested the 1260 level as support several times. The completion of one pattern does not automatically lead to the development of another. The move to the pattern targets included two sustained uptrends and a period of consolidation sideways movement in mid-2010.
The S&P is a complex short-term chart and this affects developing longer-term outlooks. The primary uptrend starting in September 2010 has been broken and previous S&P history suggests this will move into a period of consolidation or sideways movement that may include considerable volatility.
The S&P has developed a small head-and-shoulder pattern. The downside projection for the pattern is near 1220, which is also the resistance level reached in 2010. This helps to define the potential width of a new consolidation trading band and this is used for upside and downside calculations.
S&P 500 USA daily chart
A rebound and breakout above 1360 has an upside target near 1510. A move below support near 1220 has a downside target near 1080; that is 20 index points above the historical support level near 1060.
The width of the trading band between 1060 and 1220 when projected upwards from 1220, sets an upside target near 1360, which captures the peak of the current S&P trend rise.
The S&P is characterised by sharp trends between well-defined trading bands. The critical level is support near 1220. A rebound from this level is bullish with long-term upside targets near 1510. A move below 1220 has a downside target near 1060.
The FTSE index is a replica of the S&P 500, although not as complex in its pattern behaviour. The base of the rounding-top FTSE collapse in 2008 is near 5600. The FTSE developed an inverted head-and-shoulder pattern before the 2009 recovery. The upside target for this pattern is also near 5600. Not surprisingly, this has become a very significant level for the FTSE.
When the 5600 target was achieved in January 2010, the FTSE moved into a sideways consolidation pattern. The lower level of the pattern is near 5000. The width of this pattern is projected upwards and gives a longer-term upside target near 6200. The FTSE has developed a strong resistance level near 6100 and this is driving the index retreat to retest support near 5600.
FTSE Index UK weekly chart
This structure gives two upside targets. The lower target is calculated from support at 560 and resistance near 6100. This gives an upside target near 6600. The larger target is created by a projection of the broad trading band above the 6200 resistance level. This gives a target near 660, just above the previous 2007 high.
The 5600 level is critical for the FTSE. A move below this level sees a retest of support near 5000. The pattern of chart behaviour suggests short-term downside pressure. The 6100 level has developed into strong resistance and a breakout above this level will also need to overcome the target pattern resistance near 6200. This limits the ability to move quickly to the upside.
About the author
Daryl Guppy is a well-known international financial technical analysis expert. He appears regularly on CNBCAsia and is known as 'The Chart Man'. He is an equity and derivatives trader and author of books, including Share Trading, Trend Trading, and The 36 Strategies of The Chinese For Financial Traders. His latest book is Guppy Trading. He has developed several leading technical indicators used by investors in many markets. His weekly analysis newsletters are well known in Asia and Australia.
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