Why aren't share markets selling off on the US situation? Investors seem to be sticking with equity allocations at this stage. Is this sensible?

The chartist's strategy in these circumstances is to let the market tell them when to act. Here are some thoughts on key levels in the Dow Jones Index

 

The Problem

 

There are of course 2 types of risk for share investors in the current situation. The obvious one is staying fully invested and getting caught in a major sell off. Markets appear to have made almost no allowance for a really bad outcome on the US debt ceiling. The broader S&P 500 index for example is trading at 13.8 times forecast 2014 earnings, only just below the late July peak of 14 times. That creates the risk that if we do start to see a real loss of confidence in world credit markets there could be a large and fast sell off in equity markets.

The other risk of course is doing some defensive selling (and possibly incurring a capital gains tax liability) only to be left behind in any scramble to reinvest if there is a sudden announcement of a political fix.

Rightly or wrongly, the majority of equity investors appear to be taking a wait and see approach, preferring not to sell unless things deteriorate.

There may be several broad factors behind this market stance

 

 

 

 

 

 

 

 

 

  1. The most obvious reason is the general view that politicians are likely to pull back from the brink
  2. Another is that even if there is a debt default it may prove to be not much more than a technical event. The key here is likely to be confidence and the sort of statements that are being made by politicians. The big risk is growing fear that sees international credit markets starting to freeze. If confidence holds the net effect of a default may only be a temporary delay in payments to some bond holders.
  3. While central banks don't have the firepower they once had, the slowdown that would result from a minor technical default would be somewhat offset for equity markets by the likely delay in Fed tapering and the consequent support for valuations

 

 

A Dow Jones Worry Index Solution

 

A chartist's approach to this problem might be to sell only if the market falls through key levels. This means selling at lower levels but perhaps with greater certainty that a larger sell off is beginning.

The Dow recently broke below a well established trend line but bounced off the 200 day moving average not far below that. It has retested the resistance zone of this old trend line but is now faltering at the 50 and 20 day moving averages just above it.

US 30 Index<a href= CFD Click to Enlarge" height="246" src="https://assets.cmcmarkets.com/images/dow-jones-worry-indicator-300x246_medium.jpg" width="300" /> US 30 Index CFD
Click to Enlarge

Against that background these might be some useful technical levels to judge how concerned the market is becoming

 

 

 

 

 

 

 

 

 

  • Pretty Nervous. Rejecting the 20 and 50 day moving averages and dropping back below the trend line might indicate mounting concern. Using a bit of a filter below the trend line a move under about 14,970 might be said to be getting into this nervous zone. That would be a drop of about 2% from current levels and would also see the 20 day average crossing back below the 50
  • Real concern. A move under the 200 day moving average could be used as an indicator of real concern. Again using a bit of a price filter to wait for price to get well below it would imply a move back to around 14,600 or a fall of about 4% from current levels
  • New valuations. I've labelled a clear break above the trend line across the May and September peaks as the "care free" zone. A break into new ground there would presumably only occur if the debt ceiling issue is resolved for the medium term and perhaps also if the market feels the Fed is going to keep rates low for some time to come. This level might be about 15,800 or around 4% above current levels.