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Trends beat talk

Trends beat talk

The sirens are wailing again. Commentators and analysts are sounding the alarms everywhere, from the august pages of the highest quality news sites to the loonier fringes of the market community. The tones range from concern to panic. Anyone judging the level of the share market from commentary might think the market is in the doldrums, at best.

It’s not just in Australia. Around the globe, almost universal negative expectations are defying unambiguous uptrends in major share markets. The divergence between market action and sentiment is extraordinary.

This translates to action. Portfolio cash levels are higher, despite dismally low interest rates. When investors buy shares they tend towards stocks with steady and local earnings streams. Think utilities, healthcare and real estate investment trusts. The majority of traders are playing the Australian share market from the short side. That is, they are selling to open, and will benefit from a fall in the Australia 200 index.

The client sentiment indicator (above, from CMC’s Next Generation trading platform) shows the positioning of traders. Two out of three CFD traders that have a position in the Australia 200 index are short. By value, 89% of the positions are short. While some of these sold positions may hedge physical portfolios, it is clear the majority of traders have a negative view of the share market, at least in the near term.

One of the first maxims taught to young traders is that “the trend is your friend”. Many investing and trading strategies are in essence trend following. Momentum investors, and traders who use crossing moving averages, are aligning themselves with the current market trend. There is a mathematical basis for embracing trends. Many studies over the years show that trends persist in share prices for longer than could be expected if price action is truly a “random walk”.

This daily chart of the Australia 200 index displays a clear uptrend (green line) that began in late 2018. A trend remains in place until proven otherwise. For the uptrend to end, it must pierce the line. At the moment, that means a fall below a level close to 5,530. Until then the chart indicates the market is more likely to keep rising.

The red line at the top of the chart is the all-time high near 6,850. Nobody knows the future. Nobody can state with certainty what will happen if and when the index approaches that level. Failure at the all-time high, and a subsequent fall below the uptrend line would indicate potential for a significant market drop. However if the index trades up through 6,850 the indication is for further gains. This may hurt investors with high cash levels and lower share market exposure.

Corrections and bear markets usually begin in optimism and exuberance. The general enthusiasm leads investors to disregard risk in an increasingly manic desire to join the market party. The euphoria spreads, and more people enter the market. A well know harbinger of a massive correction is pundits arguing, in one form or another, “it’s different this time”.

Another is the taxi driver effect, possibly updated. If your Uber driver is asking which shares she should buy, the market is potentially topping out.

In contrast, the current gloomy consensus means portfolio cash levels are higher, and buyers favour sectors that produce steadier and more reliable earnings. There is little evidence of the ingredients that produce a stock market crash. Investors may benefit from following the leads provided by the price action, rather than listening to the prophets of doom.

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