In this low interest rate environment, investors have continued to buy good quality dividend paying stocks with relatively stable earnings outlooks. Many of these stocks have been pushed to Price: Earnings Multiples that are well above their long term average.
This is understandable given low interest rates on fixed interest investments. Indeed this process could easily continue with earnings yields on these stocks falling (PE values rising) to bring them even closer to bond yields.
From a short term trading point of view though, these high valuations are making some stocks vulnerable to a sharp sell off if a bit of bad news comes our way.
In this situation technical set ups can be useful, providing a logical place to sell stocks with a close stop loss to test the waters and a relatively good reward: risk pay off if bad news emerges.
Major international packaging company, Amcor looks to have arrived at one of these situations.
Before, I get on to the chart set up, I thought it might be useful to include Amcor's PE chart to provide some historical perspective on current valuations.
The chart below shows Amcor's price as a multiple of analysts' earnings per share estimates for the current calendar year. These estimates are surveyed by Bloomberg.
A couple of things stand out:
- The rally in the Amcor price from late last year has been mainly about investors paying higher PE values as opposed to analysts increasing their earnings outlooks. The PE value has risen from 13 to 17.5
- The big spike in PE values in 2008 was a different situation. Share prices were actually falling then. However, PE values spiked because earnings estimates fell even further
- At around 17.5 times, Amcor's PE valuation is now well above the peak made at the top of the bull market in 2007.
The setup here involves a wedge/channel type formation (green lines).
This comes at a time when price is well above both its long term trend line and its 200 day moving average (blue lines).
In this situation it's common to have a total of 5 tests of the pattern's outer boundaries.
Another common behaviour is for the 5th and final test of the wedge to make a false break through the resistance (often called a throw over)
So if this resistance is going to be respected there are a couple of possibilities. Price might form a trend peak right at the resistance line or there could be a throw over.
The third alternative of course is that none of this happens. The existing trend could easily keep going with no peak around current levels. In that case there is no setup.
Rather than just selling at the resistance line now, one approach is to wait for the chart to provide more of a clue about which of these things might happen. This type of strategy waits for the trend peak to be made before selling
As things currently stand, a peak at the trend line would be confirmed by price staying below yesterday's high and then moving below yesterday's low at around 9.67 (arrow on the chart)
The same logic can be applied to any trend peak made a bit above the resistance.
Once the position has been entered, a stop loss might be placed just above the trend peak. If that's taken out, the wedge pattern has failed
The long term trend line and 200 day moving average might form the basis of profit objectives.
With high pay off ratio strategies like this it can also pay to have strategies to move the stop loss down behind new failure points to begin protecting profits if a significant downward correction does develop.