Last week's price action gave us a clear break of the uptrend that had lasted over 3 months and yielded a peak to trough rally of 20%.

This week, I outline some thoughts on what this trend break suggests for medium term trading strategy in light of a comparison of international indices.

Valuation Theme

Last week, I made the case that it's there's now real doubt about whether Australian interest rates have further to fall. This in turn reduces the prospect of another strong leg up in PE values for the Australia 200. From here on in, upward momentum in the index may be depend on an improved outlook for earnings growth. If PE values do continue to climb it is likely to be part of an ongoing global move in response to central bank stimulus.

Comparing the forward PE values of different indices is only ever a rough guide. It can be clouded by a number of factors including the different industry weightings in each country. Even so, the table below suggests that our market is now near the front of the pack on valuations.

*Index Price Earnings base on Bloomberg survey of analyst earnings forecasts for 2013 *Index Price Earnings base on Bloomberg survey of analyst earnings forecasts for 2013

This suggests the Autralia 200 could underperform for a while. If there's a global correction ours may be a bit deeper than in other countries as it comes back to the average. Alternatively our index could move a bit lower while others remain broadly range bound.

Daily Chart

Although the 200 had previously nudged below support levels, last week put the issue beyond doubt with a clear break of the trend line and 20 day moving average. These had both done a good job of defining the lower boundaries of the latest rally once it became established.

The low last Thursday represented a 28% retracement of the November/March rally in the Australia 200.

With retracements like this, there's a good chance that the correction will be at least 38.2% and very often up to 61.8% or more before it ultimately ends. As the Fibonacci tool on the chart below shows, that kind of correction may see us back into the 4640/4840 zone before it's over.

If you accept this logic then for a swing trader, a basic strategic stance would be looking to sell any rallies that peak below the March high.

Australia 200 CFD - Daily. Source: CMC Tracker Australia 200 CFD - Daily. Source: CMC Tracker

4 Hour Chart

Zooming in for a closer view with the 4 hour chart, suggests that we are still in the first leg of a corrective decline.

I've made the case on the chart below that this has so far taken a 3 swing structure. If this holds true, this first leg in the overall correction may have another 5th move down below "3" before it's finished.

Australia 200 CFD 4 Hour. Source: CMC Tracker Australia 200 CFD 4 Hour. Source: CMC Tracker

Overall we may be in the "A" leg of an ABC correction. The end of a 5 swing "A" leg would then see a "B" leg rally.

For this view of life to remain correct, you would not want to see price overlap through the low at "1". There was a narrow squeak this morning when news of an agreement on the Cyprus bank restructure first hit. Price stopped right at this resistance line and the 50 period moving average.

If we break above the dashed blue resistance line at "1" now, then we may be in for a decent move higher at this stage. In this case, I will be on the lookout for opportunities to sell into strength.

If we get a rally now, the area bound by the 61.8% retracement level and the old trend line support (broadly the 5050/5125 zone) is the sort of area that would look a chance for a sell setup in anticipation of a decline to the 4850/4650 area.

The Week Ahead

There's not much on the schedule of economic releases in what, without Europe, could be a quiet weak leading into the Easter break.

However, the situation in Europe has plenty of potential for volatility. A couple of things to focus on might be

  • Ongoing reaction to the Cyprus bank restructure and what happens when the banks reopen
  • Formation of the new Italian government and the prospect of another election.