Vedanta Resources (VED), the diversified metals and mining company, disappointed investor in November after reporting a 17 per cent drop in first-half revenues on the back of falling commodity prices. The stock fell sharply on 15th November and the slide in the share price has continued ever since.
Like other mining stocks, Vedanta’s value has been affected by the global slowdown, the stock is in a long term downtrend and the latest breakout does not bode well for the future. There is potential for further losses in the medium term.
This year and up to October 2013 the stock was trading sideways with support just above 1,000p. The support line drawn from the lows in March and July this year is in fact the neckline of a head and shoulders pattern [S,H,S]. We know it’s a neckline because the pattern was confirmed when the stock broke below the support line in November. The completion of the head and shoulders marks the start of a new leg down, possibly an impulse wave in five waves [i,ii,iii,iv,v].
As you can see this impulse wave is not yet complete. Firstly, the decline must be in five waves but so far prices are in the third wave. Secondly, the target given by measuring the width of the head and shoulders is near 650p which is also a level near the lower line of a down channel. This suggests that the stock will move to 650p in the medium term. A possible scenario in the short term is a rally to 900p to complete wave iv followed by a decline to 650p to complete wave v.
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Despite the recent good economic reports, sentiment remains bearish and the stock markets are staying down. As I have mentioned before the FTSE 100 is the leading index and the S&P 500 is now catching up with the FTSE 100. Companies listed on the FTSE 100 are exposed to emerging markets which are a barometer of the global economy and include major market-moving sectors like mining, oil and banks. When the FTSE turns down, it’s time to be fearful.
I also said a few months ago that the FTSE is forming a major top. The extreme in bullish sentiment recorded in April and May this year was the first signal of an impending top. How can you tell when the market is reaching the top? Simply by looking at the Investors Chronicle covers. The first cover below titled “Return of the bull” was published on 15th March 2013:
When the stock market has had a good run and public interest is so high that it's casually discussed over drinks, this can be viewed as a negative. Likewise when the bullish story appears on the front cover of a major investment publication, we shall turn bearish. The message “prepare for the coming equities boom” should be interpreted as “prepare for the next bear market”. The above magazine cover has given a good sell signal. On the day it was published the FTSE 100 closed at 6489, fast forward one month and the FTSE 100 was down 4% with the low of 6225 recorded on 17th April.
From there the index rallied until 22nd May from 6225 to 6875, this extraordinary run up created a second wave of extreme optimism and a few days later on 24th May a second bullish magazine cover was published:
The cover-page article is summarised in the following sentence “You don’t need to know more than other investors to beat the market. Instead, you need to start taking on risk”. For a contrary signal, the timing of the article could not have been more precise; the FTSE 100 declined 9.4% over the next four weeks. Note the unmistakable change of tone which is decidedly more aggressive, in April the message was to be invested in the stock market, but in this article investors are blindly told to take on more risk. Unfortunately any investors who took this advice would have lost a lot of money as the message came at the start of a massive decline. To the astute investors out there, this magazine cover story once again offered an excellent contrary sell signal.
With the FTSE currently trading near 6500 and well below the high set in May this year, it appears that both magazine covers gave accurate warning signals to those who are paying attention to sentiment. Sentiment analysis is a powerful tools and I will have more to say on the subject at the next meeting of the Society of Technical Analysts on 10th December where I will discuss the effect of sentiment on stock prices.
Meanwhile good economic reports means the fear of tapering has returned. If the nonfarm payrolls report out on Friday is strong, then the stock market decline could accelerate. We are in a weird world where good news is bad news - I say weird because this is not usually how the stock market works! There’s an army of fundamental analysts who like to buy when the news is good, so in theory the FTSE should be rising, not falling. What will they do when the news is bad and QE continues? They are not going to buy bad news surely? The Fed has indicated that QE cannot go on forever, there will be a time when the music will stop and market participants will stop dancing. This moment is fast approaching.
Right now sentiment is bearish. Like on 15th March and 24th May my sentiment indicator gave me a signal to go neutral on 26th November. I therefore locked in my profits and protected my portfolio in anticipation of a potential move lower. And my call was right as since then the FTSE is down more than 100 points.
The FTSE is now trading around the 6500 level, the decline has been noteworthy considering that the S&P is not far from its all-time high. The difference between the two indexes is that the S&P is still in the early stages of the decline but the FTSE decline is more developed. Perhaps the FTSE will start to outperform the S&P in which case there is not much downside potential left. And if sentiment turns positive we can look forward to a Santa rally.
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By Ashraf Laidi
When Fed Chairman-nominee Janet Yellen said in her testimony earlier this month that stocks were not in a bubble, citing PE ratios, many found it a fresh motive to buy. 8 months after the S&P500 broke a new record to take on its 2007 highs, the index is up an additional 16% from those highs. Year-to date, the S&P500 is up 27%, which if maintained, would be the strongest year since 1997, when it logged 31%.
PE Nearing 2007 Levels
Back to the price to earnings ratio. Currently at 17 times earnings, the multiple is dangerously close to the 17.60 level reached in October 2007, just prior to the 2007-09 crash. But 17.0 is no comparison to the 30.0 multiples prevailing at the height of the dot com bubble. Low PEs relative to soaring prices imply soaring earnings as a result of deep cost-cutting from companies. Up to what point can earnings defy slowing sales remains a key question. A more reassuring metric for the bulls is the price to book ratio (focusing on balance sheet book value). Today’s price to book ratio for the S&P500 is at 2.6, compared to the 2.9-3.0 prevailing in June-September 2007 and the 4.9-5.0 prevailing in Q1 2000.
Breadth Remains High, but…
A key distinction from the late 1990s bubble is the breadth of the rally. 446 socks in the S&P500 are up, which is the most since 1980. Half of those stocks are up more than 30%. Today, 82% of S&P500 stocks stand above their 200-day moving average, compared to 63% in September 2007 and 20% in February 2000. Do keep an eye on this indicator if it drops below 75% within the next 4-6 weeks as this would signify a clear negative breadth divergence.
Fed Remains on a High
For the first time in history, US central bank policy is at its most aggressive mode while stocks are at their highest levels. Most notably, the Fed has signaled it is in no hurry to withdraw its stimulus. Now that Fed has de-linked tapering from any rate hikes, the notion of reducing asset purchases may not necessarily be negative for equities. And what was an unemployment threshold of 6.5% for raising rates has now become a threshold of “considerably below 6.5%” before rate hikes are considered. This further supports the notion that interest rates will not be raised before the end of 2015.
Rather than asking whether stocks are due for a sharp decline, the question is how long is the next price consolidation before the next move up? While a move towards 1850 remains viable, we must closely watch the PE as it nears 17.6, book value nearing 2.9 and the 200-DMA breadth nearing 80%.
Ashraf Laidi is Chief Global Strategist at Leading Spread Betting Company - City Index