Is it time to be bold and buy?

Equites markets are closing in on that ‘critical mass’ point where underlying macro and micro fundamentals are thrown out the door and the mass momentum trade takes over – in fact, we are probably already there.

Source: Bloomberg

This means we need to start asking the next big question, is it time to buy?

No market participant will ever pick a bottom or top perfectly but they can see the signs of when each is forming.

March-April this year is a clear example of a topping situation; valuations had gone beyond stretched, the underlying fundamentals were not justifying the index to be touching 6000 points as investors became one-eyed on yields, which led to upside trading records consistently being broken on the momentum.

A similar situation is currently developing on the downside, and this is what leads us to believe we are nearing a bottom.

Nearing the bottom

The ASX logged its fifth consecutive decline yesterday. It has only logged six consecutive declines three times since December and it has never logged seven.

The ASX has now declined eight out of the past nine days – something it has only done once in 2015 and three time in the past four years. The longest sustained decline was nine out ten consecutive trading days, which occurred in September last year.

The price/earnings (P/E) ratio correlation are also becoming over stretched on the downside. Compared to the 12-month blended forward P/E ratio to the ASX cash market, the ASX is trading at about 13.9 times the lowest level in two years. Yet, its current P/E has it at 18 times. Markets, in theory, are forward looking – the forward blended P/E on a historical basis is entering ‘cheap’ levels.

The underlying commodity markets are also reaching some critical levels – iron ore is falling but is showing signs of responding to news that Chinese smelters are being cut back.

Oil is also showing signs it’s at the ‘capitulation’ point, with record levels of short interest in WTI, to see it trading at the lowest level since 2008. The supply side is catching most of the market’s attention as Iran added to the Saudi commentary overnight in looking to further increase its production. Demand in the US and China has not yet materially responded to the price shift for a fundamental shift to happen.

However, oil (both Brent and WTI) is now trading under fair value according to Deutsche bank. A pattern that never lasts more than two weeks and normally averages four days (we are now into the second day).

There are signs that the ASX is coming to the critical point where sustained selling will be questioned. The Fed, RBA minutes and MYEFO might give the ASX the final little push it needs to the downside to get buyers to finally see value worth backing – be bold, because the value is there.   

Ahead of the Australian Open  

The SPI and our out-of-hours markets see the ASX down a further 20 points to 4909. However, we have started to see buying coming in when the ASX touched 4900 points. Iron ore added 2% yesterday and all industrial metals were in the black in London.

BHP’s capitulation is also coming to a point of finality; I believed it was a trap in the $20 handle and there is likely to be further bad news at the half year numbers, however even with this factored in, its discount net present value is over 25% a level that in the past has led to buying. 

These calls may not come to fruition today or even in the next few days, but the Australian market is primed for a rally.

This information has been prepared by IG, a trading name of IG Markets Limited. In addition to the disclaimer below, the material on this page does not contain a record of our trading prices, or an offer of, or solicitation for, a transaction in any financial instrument. IG accepts no responsibility for any use that may be made of these comments and for any consequences that result. No representation or warranty is given as to the accuracy or completeness of this information. Consequently any person acting on it does so entirely at their own risk. Any research provided does not have regard to the specific investment objectives, financial situation and needs of any specific person who may receive it. It has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such is considered to be a marketing communication. Although we are not specifically constrained from dealing ahead of our recommendations we do not seek to take advantage of them before they are provided to our clients. See full non-independent research disclaimer and quarterly summary.

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