Since my last article on April 22nd the market has largely tracked sideways around the 3660 to 3690 mark, just short of the “magic” 3728 resistance I spoke about.

Last Thursday (30th April 2009) the XAO jumped above this resistance before settling at 3737 on Friday 1st May 2009.  Positive news in the US on the weekend saw the DOW jump up and Australia followed closing at 3846 on Monday 4th May 2009.  Technically this is very positive move and unexpectedly it may indicate that the market is going to break upwards from here.  The 3728 resistance was a strong one and any rally above this point could be sustained.

When price action breaks above a resistance line that line then becomes a potential support.  If this happens it is very significant because our market would have found its bottom.

It’s too early to make this call yet as I would prefer to see the market come back to hit the line and bounce off again but this doesn’t always happen.  The next weak resistance is around 3950 and then we have all the way to 4300 before another resistance point is found.

There are potentially a number of ways to trade this:

1. Buy shares now and hold for a few weeks before writing calls – this would enable you to take advantage of any upside and position yourself for writing when appropriate – remember the “best” way to do the covered call strategy is to write as often as possible.  The risk is if the rally is not sustained the shares will fall in value.
2. Buy shares now and hedge them for 2 to 3 months just in case the rally does not sustain itself – this would enable you to take advantage of any upside and position yourself for writing calls when appropriate and it would also protect you on the downside – this is my favoured strategy at the moment because it would not surprise me if the market falls back to lower levels in the next couple of months.  Really you are getting the “best of both worlds” in this strategy.  Your risk is the cost of the puts to hedge.
3. Buy 2 to 3 month calls and exercise them for stock at expiry or sell for a profit if in the money – a higher risk strategy in that 100% of the funds you put into the calls would be at risk but also, if you use it sensibly, it could be a very low cost way to take advantage of any rally without having to commit to the stock.

Our broking team have suggestions on stocks and options for active traders.  Please call them on 1800 000 369 (Press 7) for advice.

Of course for passive investors now could be a fantastic time to review your strategy.  As a minimum we highly recommend that you have a regular investment plan set up where you contribute a small amount each week, fortnight or month to your investments.  From 6th March 2009 to 4th May 2009 the market (XAO) has risen just under 24% from 3111 to 3846.  If you were making regular contributions during this time you would have gained significant advantage from this move.  The average for the market from November 2008 was around 3450 so your potential gain would have been around 12%.  
 

If you consider this chart from the last “crash” – 1987 to 1997 it tells a very interesting story.  Presuming you had committed all your funds in October 1987 you would have only seen an 18% increase in your funds over ten years.  However if you had invested regularly over the period every month contributing the same amount your portfolio would have increased on average 137% – a VERY powerful argument for a regular investing system.

Remarkably whilst most people are scared of the share market’s volatility and get very sensitive about price movements this is exactly its advantage over other styles of investing – you can buy quality shares at a discount to their real value from time to time.  And this is true with Managed Funds as well.  The last six months may very well have represented the best buying possible for years to come.

Traditionally when the market recovers from falls such as we have seen in the last 2 years, it recovers quickly and most people miss the biggest gains which are to be had because they stay out.

Don’t miss out on the potential upside from here by staying on the sidelines.  All of our GEMs funds allow you to invest from just $100 per month.  Call us on 1800 000 369 to set up your investing plan. 

It will pay investors to take an active strategy in the coming few months as the market is sure to be volatile.  Nothing is certain yet but these are certainly very interesting movements.

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Will the rally sustain itself?

By Peter Spann

The next few weeks will be critical for the market.

Since the beginning of March the world’s markets have seen a considerable recovery.

The XAO (All Ordinaries) has risen from its low on the 6th March 2009 of 3111 to a peak of 3728 on 17th April 2009.  This point is very significant from a technical point of view as it has now hit that resistance three times and fallen away from it. 
 

If we go back to the last market peak on the 19th May 2008 (6035) we have effectively seen two retraction phases. The first finished on 15th July 2008 at 4910 and we saw a sideways consolidation at that point which lasted until the 15th September 2008 when the market fell through, rallied briefly and finally fell through support for good, closing on the 6th of October 2008 at 4544.

From there we reached a support on the 28th October 2008 of 3755 falling from the highs made on the 14th and 21st October 2008.  On the 5th November 2008 a new high of 4287 was reached before the market fell away again breaching the 28th October 2008 support closing on the 13th November at 3672.

Effectively the market shed all its gains in the last peak meaning you would have to have gone back until 1999 to be guaranteed of an investment point below current market levels – a whole decade.

At the beginning of March prices got to their lowest since 2003 about the same point before the big market run up to October 2007.  This was a fairly important number since the market hit around that as support on 30th April 2002 and resistance on the 30th June 2000,  31st August 2000, 31st January 2001 and 31st October 2003 creating the consolidation prior to the run up to October 2007.

Prices were so low that if yields had remained consistent (and that’s yet to be proven) we saw PE’s as low as 7 times on massive blue chip companies.  And the market reacted quickly to improving news in the US with rallies there and here, with financials leading the way.

And this is where it starts to get significant to current trading.  The market rallied briefly on 14th of November 2008 at 3726.  And this resistance has been tested three times since, on 7th January 2009 at 3728, the 16th April 2009 at 3725 and finally the 17th April 2009 at the magical 3728.  It has since fallen away.

So the question remains, what now?

The share market values future projected growth and income.

It seems the current market sense is that that “magic” point of 3728 is about the right top point for current valuations and something significant would need to change for that to vary. We’ve had a fair bit of “good” (well not bad) news lately and little bad news.  I believe the market is waiting to determine balance of probabilities.

In other words at the beginning of March with prices and PE’s so low the market thought on balance of probabilities it had over sold and there was money to be made.  Right now collective thought seems to be that we have reached the top end of pricing support for now.

A reasonable support seems to be forming at about 3300 and at worst the low at 3100.

So on balance of probabilities a sideways consolidation seems to be forming between 3300 and the “magic 3728” (around 3700).  The market tends to stay in these sideways patterns until there is a significant change in sentiment – or until the balance of probabilities shifts in one direction or another.

If the market jumps above 3700 it is important that it stays there.  While this may seem an obvious statement there will be no sustainable rally until this resistance point becomes a support or the market remains consistently above it.

When you remember that the share market is a forward looking instrument and it prices 9 to 12 months in advance I believe we are merely in a holding pattern until we get some more positive or negative results from the economy or the companies that make up the market.

While critics have jumped on Rudd for saying the “R” word and “admitting” a recession was inevitable he is only saying what economists have known for some time and you are ready to hear. Contrary to what you might think this pronunciation is actually good news.  After all a recession is just a couple of quarters of negative growth and sentiment seems to be “if that’s all we have to deal with then it’s going to be OK”.  Remember it was only a few months ago the “D” word was being bandied around with abandon.  Also the economy lags the market.  Just as the markets fall before the economy turns down the market usually rise before the economy too.  So this is good news, it might mean the drivers of the economy are finally catching up with the market.

Glenn Stevens, Governor of the Reserve Bank, in his presentation “The Road To Recovery” said yesterday, “Whether or not the next GDP statistic, due in early June, shows another decline, I think the reasonable person, looking at all the information available now, would come to the conclusion that the Australian economy, too, is in recession.”

“The global economy is in recession. Virtually all of Australia’s trading partners are contracting. In fact almost every country with which we would normally make comparisons is in recession, and for many of them it is a bad one,” Mr Stevens said.

“It is very rare for Australia to escape an international downturn and there is no precedent for avoiding one of this size. We, like most countries, have trade and financial linkages to the rest of the world. We are all aware of what happens abroad, and our own expectations and economic behaviour cannot but be affected by those events.”

Prime Minister Rudd hinted that the May budget will contain a further economic stimulus package.  “We must therefore, through the Budget, continue to provide economic stimulus,” he said.

Again, it is actually good that our leaders are talking like this.  Now that they have stopped the political dance of ignoring the “R” word we can all concentrate more on rebuilding.

This is the pattern we are seeing in the share market too. If I am correct and a sideways pattern is developing that could form the basis for a later recovery.  Of course it could also form the next downwards platform too.

There are still the issues of the huge housing slump in the US, credit still being as tight as a frog’s bottom, a general retraction in spending and fear gripping the public, and the unknowns in China and other developing country demand / supply. But I think it is safe to say that a lot of that is already priced into the market however, any of these things could trigger another round of tightening credit, company failure and economic retraction.  And that would tip the balance of probabilities to the down side with another round of selling.

Any fall below 3100 is potentially catastrophic with support below that point only found potentially at 2400, 1800, or 1400.  The good news is and always has been that even the worst downwards movements has lasted a maximum of about 3 years which means we are at worst half way through.

The worst downwards movement in history was of course the 29 crash which lead to the Great Depression which saw 34 months of downwards movements wiping almost 90% of value from the market at its peak.  There are parallels to be drawn between now and then but there are also a lot of differences too.  Never before have governments moved so swiftly and so massively to stem the tide of an economic slowdown and never before have the underlying economies managed by those governments (with the possible exception of the US, UK and parts of Europe) been in as good a position prior to the slow down.

My current sense of this is that it is looking more and more like 73/75 where the bottom was found about 21 months after the top and the market went through a series of increasing sideways consolidations before finally recovering.

It is plausible that we haven’t seen the bottom yet, however what I believe is the most likely outcome for the foreseeable future is a series of sideways movements bottoming at 3100 and topping at 4000 with the most likely movements being between 3300 and 3700.

There are three strategies that work well in sideways markets that you could consider employing:

1. Covered calls.  Some traders would considered a sideway consolidation (or channel) ideal for the buy write strategy and I would agree.  High volatility at the moment does mean that premiums are high which is very good news.  Blue chip shares are producing high premiums and you have the bonus of potentially high dividend payments as well – this is an excellent income generating strategy and many of our Stockbroking  clients have been doing very well of late.  For example we recommended BHP on 25th February 2009 at $29.69 and to write the March $31 call.  When it was exercised the return would have been 6.6% net of all costs for the month!   The Stockbroking team have a current BHP recommendation – call them on 1800 000 369 if you are a client and are keen to trade.
2. Dollar Cost Averaging – this is making regular top ups to your investing portfolio regardless of market action.  At the moment, historically prices are low and yields for quality stocks are comparatively high.  While it is impossible to time the market it is possible to take advantage of this unique opportunity by making a regular contribution to your wealth plan.  Many people allow fear to stop them from doing so but regular contributing is one of the most proven wealth creation strategies which takes advantage of price variation and compounding to build wealth over the long term.  Now is the time to start or continue your contributions.  And indeed you would have seen a handy increase in the value of your portfolio in the last couple of months if you had stayed in and many of our GEMs investors have been successfully following this strategy.
3. For the adventurous you can trade channels by taking long positions (calls or owning the physical stock) in up swings and short positions (taking puts) in downswings.  In order to do this you obviously must have the level of skill necessary and be prepared to take higher risks.  If you’d like to know more consider attending the Super Trader seminar.

Even though friends who are selling property have reported that there are plenty of people out there bargain hunting by making ridiculous offers I have yet to discover one of those elusive property bargains.  Yes, prices are off their best, in some cases by as much as 30% but typically of Australians, most people are still holding out for respectable prices.  So, while it is unlikely that in ten years time anybody who bought property today would lose out the anticipated bargains have been hard to find.

Not so in the share market. NAB bottomed at $16.03.  Yesterday (21st April 2009) it closed at $21.16.  CBA bottomed at $24.07 and closed yesterday at $35.88.  BHP bottomed at $21.10 and closed yesterday at $31.56.

Using CBA as an example your average buy price over the last 16 weeks would have been $30.79^.  Annual dividend yield at that purchase price would be 8.63%*.  That’s my idea of a bargain.

If you’d been clever enough to pick the bottom the yield would be as high as 11.05%.  No wonder people were rushing to buy at this point – that is a genuine bargain, even if the market had continued to slide.  And that’s why dollar cost averaging is do useful – if the market had continued to slide you would have simply bought more shares at lower prices.

The big banks are having a field day at the moment – they cleaned up a lot of small competitors, have money to lend thanks to the government guarantee, their margins are as high as ever and people are using the first home owners grant to borrow to buy safe assets, so it wouldn’t surprise me if they continued to gain as high a profit if not higher as in past years.  However a couple have announced that they are cutting dividends and Bad and Doubtful Debt provisions are likely to spiral. The banks that are reporting (half year) ANZ, NAB and WBC will, most probably, “clear the decks” and try to get as much bad news in as possible.

So while they may lead any correction as they have led the rise, I still think they offer excellent long term value, especially if you are looking to buy at the bottom of the channel.

The next two big hurdles we have to get over are reporting season both here and in the US.  Continuous reporting in Australia means there are rarely big surprises when it comes to actual reporting for the blue chip companies.  This is less true for the US so the market will remain jittery at least until the end of the year when real results are reported.  So far results have been very promising with banks reporting bigger than expected profits or less than expected losses and the big bears (airlines, auto manufacturers and financial services companies) not getting shellacked as badly as anticipated.  If this holds up in the last quarter reporting we may well have seen the beginning of the end.

So in all some positives from the market.

Yes we could and probably will see a fall from here back to lower levels but this is all part of the consolidation phase I believe we are entering and if that proves to be the case that’s good news for all of us.

The residential real estate bubble in the US, the collapse of commercial real estate prices, the decline in consumption, corporate and personal deleveraging (debt reduction), economic recession and potential decline in demand from manufacturing (especially developing countries) are still real risks that could tip the balance of probabilities to the negative but there are a lot of positives emerging as well.

At the moment we continue to take a conservative stance in managing the GEMs funds.  If the market recovers swiftly this may mean we will lag but it also means we are ready to invest when the opportunity presents itself and if there are further downturns we will continue to outperform.  I think this is prudent in the current environment.  Investing is all about balance of probabilities and identifying high return potential whilst minimising risk.  We have identified a number of opportunities and we are now looking for the right window to present itself.

If you are looking to take advantage of the future you may well like to invest just $98 and attend my “Welcome to Wealth” seminar coming up in May.

The road back will be long and bumpy yet but there are still some genuine bargains to be had for smart operators and while it is still too early to call it is looking more and more like there is more opportunity then danger coming up.