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With a month to go in 2016, what are the prospects for further gains, or a slip to lower returns?

The 31st of December is fast approaching. The Australia 200 index is up just over 1%, with a dividend yield including franking around 5%. The experience in individual stocks has been much more volatile, but this modestly positive impulse expressed by the index gains should mean most diversified investors have done “okay”. 

With a month to go, what are the prospects for further gains, or a slip to lower returns?

This daily chart shows the steps the market needs to clear to break higher or lower. No-one can state the future with certainty, but an examination of the more probable scenarios may inform investor thought and action as market activity wind down into the Christmas / New Year period.

Although sideways moving markets often frustrate investors, one upside is they can provide a clearer view of key inflection points for the broader market. Where there is plenty of market activity at a price level there is higher visibility of the collective decision of the market.

Chartists sometimes disagree about which support and resistance levels are more important. There is art as well as science to technical analysis, so the lines on the chart above represent my view on the matter.

The first factor to note is that the index is currently sitting close to the middle of the two year trading range. The overhead resistance at 5385 (lowest red line), and the way the market index behaves if/when it approaches this level is the likely first indication of the market direction into the end of 2016. If the index fails at this level and starts moving down, many would suggest downward momentum and a potential test of the lows closer to 5050.

On the other hand, a push up through 5385 could have investors cheering. This kind of positive move could set the scene for a Santa Claus rally, with an initial target around 5725.

A move into either the highest or lowest zones defined by these support and resistance levels seems less likely. However one of the lessons of the last few years is that almost anything is possible. Current measures of short term volatility indicate the average (mean) daily move is 1%. Six or seven straight days of a single direction would see the index break into these end zones.

For this reason I’m sticking to my year end call of 5900, if somewhat nervously. While a number of factors will need to fire, it is still an attainable level for the index. Reasons for investors to be cheerful include:

The Trump sentiment turnaround

The market response to the president-elect’s acceptance speech is a remarkable change. The Dow Jones Industrial Average gyrated through a 1050 point range in a single 24 hour session. Climbing from the pre-speech lows to close at the high, the markets showed a clear preference for president Trump over candidate Trump. This perception that the new US administration will prove positive for the local and global economy must remain in place if the index is to move higher.

Ironically, this means the US Federal Reserve needs to go ahead with its mooted interest rate rise at its December 13/14 meeting. While higher interest rates hurt share valuations, the signalling effect of the Fed pressing ahead, and the implied confidence in the US economy, would more likely support higher levels for share markets despite the valuation impact.

A falling AUD is another important potential contributor to a higher share market in Australia. The slip below 0.7400 US last Friday night may see a test of the recent lows near 0.7150. Naturally a lower AUD makes local shares cheaper for global investors. Further falls in the currency could bring international participation to any rally.

Finally, commodity prices must maintain, or build on, current levels. Support for mining and energy stocks is an important component of market strength. If iron ore holds above US $60 a tonne, and oil above US $40 a barrel, the commodity exposed sectors will likely continue to see support.

It’s a lot to ask that four important and supportive conditions remain in place, or indeed improve. However, it does occur and this sort of blue sky could see the Australia 200 index spare yet reach heights few dare to predict.

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