It’s Time to Avoid This Sector of the Stock Market

Aussie stocks bounced strongly yesterday. The ASX 200 finished up nearly 1%. And overnight, US stocks had another good session, rising around 1% on — what else — hopes of additional stimulus! That should translate into another day of green for our local market.

How far could this rally go?

Well, at a guess, I wouldn’t be surprised to see the market head back towards the 50-day moving average, which is the blue line in the chart below.

Given the market is still technically in a bullish upward trend, there are plenty of traders and trading machines that will stay with that trend until it changes definitively.

Free Report: ‘The Top Two Gold Stocks on the ASX’

The fact that the market found support at the 200-day moving average (the red line) is a positive for the bulls.

S&P/ASX 200 XJO (ASX) - 1 DSay Bar Chart - AUD - 20-08-19

Source: Optuma

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The other point to note is that the recent big corrections in the market resulted in widespread selling. The chart below shows the ‘advance-decline’ line for the ASX.

It’s a messy looking chart. But it’s actually pretty straightforward to read. Those spike lows you see in August represent net daily declines on the ASX of around 900 stocks.

ASX Advance Decline- ADDASX (ASX) - 1 Day Line Chart - AUD - 20-08-19

Source: Optuma

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This is an extreme reading. It suggests the market was very ‘oversold’ following both the early August sell-off, and last week’s plunge.

Unless the market is extremely weak (suffering from poor fundamentals and poor investor sentiment), you nearly always see a bounce from such oversold levels.

So I would expect this bounce to continue to relieve stocks of their oversold condition.

But then it’s a case of ‘then what’.

When in doubt, always look to the fundamental driver of markets: company earnings. And on that front, the trend is not your friend. Expectations for US corporate earnings have been declining steadily this year.

The Wall Street Journal reports:

Investors counting on a corporate earnings rebound in the second half of the year are risking disappointment.

Wall Street analysts have cut their third-quarter profit estimates in recent weeks, painting a bleak picture for investors already grappling with a simmering trade war, pockets of economic weakness and ominous signs from the bond market.

Despite this week’s partial reprieve from the Trump administration, the latest round of tariffs on Chinese imports compound the problems already facing many companies and threaten to stifle their profit margins. Especially vulnerable are manufacturers, miners and retailers.

At best, earnings across the companies in the S&P 500 will grow 1.5% this year, FactSet projects, far short of estimates for growth of more than 6% that analysts initially forecast in January. Worse, a few analysts predict earnings could end up contracting for 2019 as a whole.

Plummeting bond yields and an accommodating Fed have held the US market up this year. But if a slowing economy eventually hurts company earnings (and it will) the market will continue to sell off.

That’s what I’m expecting, anyway. That is, a relief rally, then more selling.

In Australia, I think the resources sector will lead the selling. The iron ore boom is over, and the big companies exposed to this, like Rio Tinto, are seeing their share prices roll over.

Confirming this growing bearishness towards the resource sector, yesterday saw the broader ASX 300 Metals and Mining Index actually decline while the rest of the market rallied. That’s a bit of a worry.

Oil prices are now trending down after peaking in October 2018. And that other economic bellwether, copper, recently traded at its lowest level since mid-2017.

Copper’s chart (below) looks weak. I wouldn’t be surprised to see further significant falls in the months ahead.

High Grade Copper Future - HGSpot (NYMEX) - 1 Day Bar Chart - AUD - 20-08-19

Source: Optuma

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On the bullish side of the coin, you have interest rate/property sensitive sectors doing better. Yesterday, Lendlease Group [ASX:LLC] reported FY2019 earnings. The company reported a 41% fall in profits year-on-year, but the stock price jumped nearly 11% on the expectation that the worst is over.

The company is also looking to offload its troubled engineering business. It reported a $337 million loss in FY19. The market is therefore beginning to price LLC as a standalone property development company with a pipeline of around $100 billion.

With interest rates falling and set to stay low all around the world, companies like LLC have a better earnings profile right now than more economically sensitive stocks like resources.

In other words, you can still make money in this market, but it won’t be as easy as it has been in recent years.

For now, I’d suggest avoiding the resource sector in general. As trade war pressure continues to hurt China, it will have an effect on bulk and industrial commodities.

The precious metals, on the other hand, look very strong here. Having said that, gold stocks are taking a much needed breather, after a very strong run. Have a look at my ‘Top Two ASX Gold Stocks for 2019’ in this free report.

As such, in my view, this is a good time to add on any weakness.

The gold bull market is only just getting started…

Regards,

Greg Canavan,
Editor, The Rum Rebellion

PS: Free Report – Bitcoin or Gold? Discover which is a better investment in 2019. Click here.  


Greg Canavan approaches the investment world with an ‘ignorance is bliss’ philosophy. In a world where all the information is just a click away at all times, Greg believes we ingest too much of it. As a result, we forget how to think for ourselves, and let other people’s thoughts cloud our own.

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