Monday, May 11, 2009

Overbought but rally still has legs

The local stock market recovered from the previous week's profit-taking dip to extend breakout rally to fresh seven-month highs last week, boosted by strong breakout rallies in markets abroad triggered by better-than-expected earnings and economic data in the region and the US and reassuring stress test results on 19 US financial institutions.

The Kuala Lumpur Composite Index (surged) 36.04 points, or 3.6 per cent, week-on-week to close at 1,026.78, supported by strong gains in Maybank, BCHB, Genting, Tenaga and Axiata which contributed more than half of the index's increase. Average daily trading volume and value ballooned to 2.55 billion shares worth RM1.97 billion, compared with 1.59 billion shares worth RM1.36 billion in the previous week. Trading volume was the highest since February 22 2007, when daily trading volume peaked at 4.7 billion shares.

Thus far, optimism in the equity market is so strong that it continues to sustain the KLCI in overbought territory and may keep it that way in an extended mode this week. The sharp gains in local and foreign equity markets are driven by belief that the worst is behind us. The KLCI may advance towards 1,054 or 1,078 before staging a correction.

The correction is necessary as the sharp rebound is not a true reflection of the degree of economic recovery as the surge was merely driven by asset reallocation from treasury markets to other asset classes as the aggressive loosening in the monetary policies by central banks around the world, especially the US, makes it unattractive to hold low-yielding assets at a time when the worst is supposed to be over and reversal in trend is supposed to set in.

Talking about the economy bottoming out, Malaysia's March trade figures released last Friday showed dissipation in the downward momentum. Malaysia's international trade improved better than expected in March 2009 as exports fell by 15.6 per cent year-on-year, lower than consensus expectation of -17.3 per cent and February's revised -16 per cent year-on-year. As imports plunged sharper by 28.7 per cent year-on-year, a trade surplus of RM12.5 billion was recorded, making it the 137th consecutive month of trade surplus since November 1997. An important observation though is a 10.4 per cent month-on-month gain in exports, led by the electrical and electronic (E&E) products segment and higher than unexpected demand from mainland China.

The recovery can be sustained and the worst showing in exports may be behind us as checks with some major multinational corporations in E&E sector revealed that orders and visibility have been improving since February.

Nonetheless, the equity market has the tendency to overreact to bottoming out news and by the time investors realise that, valuations would have ran ahead of fundamentals. We may witness more volatility as the month passes by as the earnings reporting season for first quarter this year will be concluded in May. So far, there have been no major disappointments and the market is expecting poorer showing on a year-to-year basis.

From the scheme of events, it can be a long and protracted recovery for major economies like the Organisation for Economic Cooperation and Development nations and euro zone.

In the US, payrolls fell by 539,000 in April, lower than the forecast 600,000, while the unemployment rate hit a 26-year a high of 8.9 per cent. A lower-than-expected reduction in the job numbers tells a bottoming out story as not only the job security has greater influence on consumption but also long-term investments such as houses and cars. This will ensure that the housing markets will not deteriorate further and affect banks.

As it is wise to pursue a trading approach in the current market, look for exit opportunities as the KLCI is expected to rise towards 1,054 this week. The KLCI has surged 150 points year-to-date and close to 60 per cent of it came from top 10 stocks in the banking, plantation, power, gaming and telco sectors. Most of them should be rated as "sell now" based on consensus target price, except for some like Genting, MMC and IJM Corp.

Technical outlook

Bursa Malaysia copied strong breakout rallies in the region on Monday, encouraged by the first manufacturing expansion in China in nine months and commitment by regional governments to start a foreign-currency reserve pool. However, stocks ended off earlier highs the next day on profit-taking but regional markets powered higher, fuelled by the overnight US rally.

The bulls returned in afternoon trade Wednesday to reverse the previous day's losses, with the KLCI bouncing back strongly from the 1,000 level. Extended rallies across the region insolvent lifted stocks the next day, with the index rising to a fresh seven-month high, prior to a profit-taking dip.

The market closed slightly firmer ahead of the weekend as buyers continued to absorb profit-taking and stale bull selling, with the lower liners staging a strong comeback to outperform blue chips. The KLCI bounced up from early low of 993.2 on Monday to peak at high of 1,037.81 early Thursday for a wide 44.61-point range prior to profit-taking consolidation to end near the week's upper trading range.

The daily slow stochastics indicator for the KLCI has crossed for a sell signal in the overbought region (Chart 1), while the weekly indicator is leveling at the extended overbought zone to indicate easing upward momentum. The 14-day Relative Strength Index (RSI) has risen steadily with an overbought reading of 77.77, while the 14-week RSI climbed higher with a reading of 65.39 as of last Friday.

Meantime, the daily Moving Average Convergence Divergence (MACD) trend indicator expanded above the signal line to indicate strengthening trend, while the weekly MACD signal line has just crossed above to the zero mark . The bullish trend is confirmed by the 14-day Directional Movement Index (DMI) trend indicator, with the ADX line sustaining healthily above the 25-point threshold with a reading of 45.53 to reinforce the uptrend.

Conclusion

While technical momentum for KLCI, especially the daily and weekly slow stochastics indicators, has been overbought for some time, the technical overbought situation has yet to reach extreme levels, suggesting there could be more upside this week before the overbought situation becomes exaggerated which would call for a more significant profit-taking correction. Trend indicators remain strong to reinforce the current rally.

Nonetheless, it would be better if daily trading volume can stabilise between the 2-billion to 3 billion-share mark for more sustainable uptrend, as a huge spike in volume towards the all-time record of 4.7 billion shares in February 2007 will most likely form a bullish peak and hence trigger a sharp profit-taking correction.

On the daily KLCI chart, note that the next immediate resistance after last week's high of 1,037.81 is at 1,040.85, the September 22 2008 pivot high. A confirmed breakout above this pivot high will target 1,054, which is the 1.618X upside target projection of wave A (the distance of 801 low to 936 high), anchored from start of the current wave C (or wave B low of 836), in the expanded flat wave 4 correction. The next stronger hurdle is at 1,078, representing the 38.2 per cent FR of the major sell-down from the 1,525 all-time high of January 14 2008 to the 801 pivot low. Immediate support meanwhile is revised upwards to last Friday's low of 1,014, with the 1,000 psychological level and 983 acting as stronger downside cushions upon profit-taking correction.

No comments: