CAPE TOWN – Anyone with even a passing interest in equity markets will be aware that the JSE is currently at levels never seen before. The FTSE/JSE All Share Index went beyond 50 000 for the first time last month and the FTSE/JSE Top 40 Index made its first foray above 46 000 earlier this week.
While these record levels may sound great if you have money in the stock market, they have also made many people wonder how long this can continue. With each new high reached, the threat of a market downturn seems to grow.
But rather than just speculating about the state the market, it’s worth looking at a technical analysis that can shed more light on the territory in which the JSE is trading. And what this shows is that there is good news, and bad news.
Bad news first
“Historically, June is regarded as the most under-performing month of the year,” says technical analyst at Nedbank Capital Peet Serfontein. “Therefore a market correction remains high on the radar screen.”
Serfontein says that looking at the market in rand terms, there are two clear warning signs. And these show up whether you are looking over short (seven days), medium (21 days) or long term (75 days) time frequencies.
The first is that the Alsi is trading above the upper Bollinger Band. This is the band placed two standard deviations away from a moving average to show a normal trading range. Going above this level means that a pullback is highly likely.
The second indicator is that the Alsi is trading beyond the relative strength index (RSI) level of 70. RSI compares the magnitude of recent gains to recent losses and any reading above the 70 level shows an overvalued asset and that a correction is most likely due.
So, given these numbers, where might the market go?
“A change in the short term trend will be a trigger for a break below 49 800,” Serfontein says. “There are similar triggers in the medium term trend at 49 400 and long term trend at 46 650.”
However, even if the Alsi falls as low as 46 650, Serfontein says he wouldn’t yet consider that a bear market.
“The 200-day psychological level is at 46 132,” he explains. “So we can easily see the market correcting 9% before psychology will view it as bearish.”
Serfontein suggests that the long term trend line does however look too steep, and a more realistic number is around the 47 600 level.
And the good news?
Serfontein says that we mustn’t lose sight of the importance of the flows of money from outside of South Africa when analysing the JSE. And that means being cognisant of how much cheap money is out there.
“As the JSE All Share has risen for four consecutive months, the aspect of liquidity overspill in the market just re-emphasises the aspect of a trend,” he says. “And you should always follow the trend. Foreigners have been net buyers of our equity market of around R22.8 billion year to date. So to be more specific, follow the foreigners.”
And that means not just looking at the JSE in terms of how it appears in local currency, since foreigners will probably convert their trading activity back into their home currency.
“Our market might be overvalued in rand terms, but when converting our market into dollar terms, and using the same logic and time frames as above, it does offer some value,” Serfontein points out. “In dollar terms the market is only trading halfway between the overbought RSI 70 level of 4 938 and oversold RSI 30 level of 4 472. And statistically, it is trading close to the lower one standard deviation band. This clearly presents another picture to the one above.”
The overall picture
Serfontein says that we can’t ignore that the levels we are seeing in the JSE point to a high level of risk. And when other factors are added into the mix, the argument that the market is not far away from a correction is strong.
“A looming ratings downgrade, the shadow of negativity about June as a trading month and the futures closeout due next Thursday might add some instability to the market,” Serfontein says. “So the risk classification to the market remains high.”
However, he adds that trying to estimate any long term market direction is close to impossible when the market is being driven by so much liquidity.
“We are all aware that instability in financial markets is a reality, but timing when the correction will occur under these circumstances becomes guesswork,” he says. “For us all.”
For those with a more technical eye, the below graphs illustrate Nedbank Capital’s technical analysis discussed above.
“To understand the chart below, which is the market in rand terms, the green colours represent the short, medium and long term trends as calculated by linear regression analysis, and they are all bullish,” Serfontein explains. “The one standard deviation channels are charted on the different time frequencies. A two standard deviation channel is charted only for the long term. The RSI 70 overbought territory is presented by the red line at 50 580, and RSI 30 oversold territory at 47 733, giving some sense of a trading range, being an odd 2 800 points. The 200-day simple moving average is at 46 132.”
The second graph uses the same measures, but in dollar terms. The red line shows the bearish medium term trend, with the longer green line the long term bullish trend, and the shorter line the short term trend.