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Not judging the market book by its cover

I have enjoyed the rally in the ASX the past two weeks. The pessimism in the ASX particularly at the end of March/early April on the Banks’ provisioning issue was overdone and provided a buying opportunity that has come at 4900 points.

Iron ore
Source: Bloomberg

I have long believed that the ASX is stuck in very ‘fat’ trading range triggered by the August 2015 Chinese yuan devaluation. Since this time, the ASX has traded in a range of 4900 to 5300 points and cannot break out of these levels.

The ASX is now testing the top of the range for the second time in the past six weeks. The previous test it was on better than expected asset quality at the banks, which was subsequently challenged on ANZ and WBC’s confessions three weeks later.

The current movement in the ASX has come from commodity price moves, but the market internals suggest another failure to break above 5300 points:

  • ASX is at the highest level since 5 January and has added 7.8% since 8 April.
  • The ASX has added 2.2% this week to go with 4.6% last week. This is the strongest two-week period since the week beginning 29 September 2015. The Aussie VIX hit its lowest level in six weeks yesterday and is below the 20, 50 and 100 day moving average.
  • 84% of ASX 200 companies are above their 50-day moving average, 74% are above their 200-day moving average. RSI for over 60% of companies are above 70.
  • Furthermore, 56% of companies in the ASX 300 are at four-week highs, which has never happened since data began.

The market internals show glaring profits, and possible buyer exhaustion. So what might trigger possible profit taking?

Overnight movements:

  • Iron ore had its second largest ever upside movement yesterday at +8.8% to $70.46 a tonne. The largest ever was a 19% move in early March this year.
  • Rebar futures however, a leading indicator of iron ore, fell 1.8% and snapped its record equalling five-consecutive days of gains. Rebar explains the declines in BHP and RIO’s London listing overnight and why BHP’s ADR is suggest the Australian listing will fall 2.3% today.
  • China’s PBoC released a statement yesterday that it will tighten lending to steel and coal producers to ‘cull industrial oversupply’.
  • BHP and RIO have joined the chorus of analysts suggesting the current spot price in iron ore is unsustainable. China’s current restocking binge will be short lived and signs iron ore will revert back to current norm will only accelerate profit taking once it begins. 
  • For example, FMG is 45% above its consensus price target and has added 19.8% since 8 April. At $3.60, FMG is an attractive profit taking price.

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