High odds of KL bourse's technical rally

Investors should continue to adopt a 'sell on strength' mentality pending solid confirmation that the global economy can escape a recession, says a research head


Last week, concern over a worsening eurozone debt crisis from a potential default on Greek sovereign debt was compounded by a warning from the US Federal Reserve of significant downside risks to the economy, and credit ratings downgrades on three prominent US banks. The negative external headwinds spilled over to force regional markets sharply lower and dragged the local blue-chip benchmark FTSE Bursa Malaysia Kuala Lumpur Composite Index (FBM KLCI) to a fresh 13-month low.

Week-on-week, the FBM KLCI plunged 64.99 points, or 4.54 per cent to 1,365.94, with half of the index's loss contributed by falls in Maybank (-60 sen), Genting Bhd(-89 sen), Petronas Chemical (-70 sen), Public Bank (-38 sen) and CIMB (-24 sen). Average daily traded volume and value rose to 807.9 million shares and RM1.53 billion from 720.8 million shares and RM1.22 billion in the previous week.

The 2012 Budget announcement and the fourth quarter of the year are around the corner, rekindling the usual anticipation of a year-end rally after a dreadful August and September that drove some stock markets back into bear territory hardly in three years. Going by a generally accepted definition of more than 20 per cent correction over at least a two-month period for a bear market, the FBM KLCI is six percentage points away from the threshold with a 14 per cent downfall from the July 11 peak of 1,597. That is not the case for the rest of the world. The MSCI All-Country World Index that tracks 45 nations has dwindled since May and met the bear market definition last week with 71 per cent of its components fulfilling the criterion.

While the 2012 Budget scheduled for tabling on October 7 may ignite interest in selected domestic growth driven cyclical (especially construction and oil & gas) and defensive plays (probably consumer and gaming), any technical rebound in the FBM KLCI and its component stocks could be shortlived in view of the fluid external climate.

Hopes for a budget rebound are not misplaced given that the FBM KLCI has advanced on eight occasions two weeks prior to and until Budget Day (or 57.1 per cent) in the last 14 years. The average gain during those periods was 3.3 per cent. Unfortunately, the same optimism was not reflected during the same period post-budget as the benchmark index fell on 10 occasions (or 71.4 per cent) with an average correction of 3.4 per cent.

However, a point to note is that in the last major pullback in 2008, the benchmark index corrected 6.9 per cent but rebounded 14.2 per cent in the two weeks prior and post-budget tabling on October 28. The advance a month later was greater at 23.1 per cent, marking the largest gain in the 14-year period as global markets rallied from their lows after the US Federal Reserve started buying US$600 billion in mortgage-backed securities (MBS) in November 2008 and boosting its holding of US banks' debt, treasury and MBS to US$2.1 trillion by June 2010.

Can we expect the same outcome in the next few weeks or months with the Federal Reserve possibly announcing a third quantitative easing or the European government officials meeting this week to find a solution to speed up the establishment of a permanent rescue fund? Known as the European Stability Mechanism (ESM), the fund was planned initially to start in July 2013 to address the need of their cash- strapped economies. While ESM is still a long shot, their immediate attention could be revamping the European Financial Stability Facility by mid-October to give it more clout in rescuing members as oppose to current limitations that involves a lengthy approval process and relatively small fund size.

In the interim period, market volatility is likely to persist and there could be further downside. Thus, investors are advised to continue selling on any rally and await buying opportunity in October, which is normally a "not so good" period for Wall Street, to ride on a possibly year-end or New Year rally. However, to caution, any surprise announcement of a general election in the fourth quarter, probably in November, is seen as a bane for the market in current conditions as it would add to the uncertainty.

Technical outlook

The local stock market slumped along with regional peers last Monday on concern Greece may default on its sovereign debt, worsening the eurozone debt crisis and adversely impact global economic growth. The FBM KLCI tumbled 17.81 points, or 1,24 per cent to end at 1,413.12, off an early high of 1,433.81. Stocks extended falls the following day amid concern over worsening European sovereign debt crisis after S&P's credit ratings downgrade on Italy. The FBM KLCI slipped 2.48 points to settle at 1,410.64, dragged down by losses in Petronas Chemicals and Public Bank.

The local market staged an oversold rebound Wednesday, in line with most regional peers on signs growth in China may withstand the European debt crisis and lethargic US economy. The FBM KLCI regained 8.4 points or 0.6 per cent to end at 1,419.04, off a high of 1,422.35. Stocks tumbled anew the next day amid a regional sell-off as the Federal Reserve warned of significant downside risks to the economy and credit ratings downgrades on three major US banks. The FBM KLCI slumped 31.23 points, or 2.2 per cent to close at the day's low of 1,387.81, depressed by heavy losses in Genting Bhd, CIMB and Petronas Chemical.

The market slump extended ahead of the weekend on follow-through heavy losses in US and European markets overnight amid concerns over weaker global growth and potential for recession in the developed economies. The index shed 21.87 points, or 1.6 per cent to end the week at 1,365.94, off a fresh 13-month low of 1,358.47, as market breadth stayed bearish with 624 losers swarming 187 gainers.

The trading range for the FBM KLCI ballooned to 75.34 points last week, compared to the 37.04-point range the previous week.

The daily and weekly slow stochastics indicators for the FBM KLCI plunged deeper into severely oversold territory following last week's sharp fall, suggesting very high likelihood for technical rebound gains this week. The grossly oversold technical situation was echoed by both the 14-day and 14-week Relative Strength Index (RSI) indicators, with their readings deteriorating to the low 20s.

On trend indicators, the declining daily Moving Average Convergence Divergence (MACD) signal line was reinforced by the further deterioration on the weekly MACD signal line, implying extended downward correction. The 14-day Directional Movement Index (DMI) trend indicator saw further expansion of the +DI and -DI lines against each other on a rising ADX line, suggesting the present downtrend is getting stronger.

Conclusion

Given the more extreme oversold signals flashed on daily and weekly momentum indicators on the FBM KLCI last week, a technical rebound early this week is a foregone conclusion, especially with the rebound witnessed on the US and European stock markets last Friday on hopes the G20 meeting over the weekend should see more concerted measures introduced to help cushion the global economy from the risk of a double-dip recession.

Still, growing bearish trend indicators point to further downward correction ahead. Thus, investors should continue to adopt a "sell on strength" mentality pending solid confirmation that the global economy can escape a recession.

Taking a look at the Dow Jones Industrial Average, the closely monitored New York stock market's 30 blue-chip benchmark index must hold above the crucial 10,600 support, which held up pretty well last week despite the severe sell-off on other major stock indices, to prevent further significant downside risk towards subsequent important chart supports at 10,400, 10,000 and 9,600. On the upside, expect resistance initially at 11,200, followed by heavier resistance at 11,600 where keen selling interest would likely register.

As for the FBM KLCI, resistance upon a technical rebound this week would initially be at 1,378, the 61.8 per cent Fibonacci Retracement (FR) of the up-trend from the 1,243 low of May 27 2010 to the 1,597.08 record high, next from 1,400 and the previous pivot low of 1,423, with stronger resistance coming from 1,464, representing the 23.6 per cent FR of the sell-off from the 1,597.08 record high of July 11 to the pivot low of 1,423.47 on August 9.

Higher upside hurdles are at 1,490 and 1,510, the respective 38.2 per cent FR and 50 per cent FR levels.

On the downside, the next significant retracement support would be at 1,327, representing the 76.4 per cent FR, which must hold to prevent further correction towards 1,293, the important 38.2 per cent FR of the upswing from 801 low in October 2008 to the 1,597 all-time high July this year.