Lighting the fuse

The share market index is on hold. But all that is about to end – and the market action could get explosive.

The share market index is on hold. As companies deliver their results to investors volumes have plummeted and the index is range bound. In fact, for the last twelve trading days the index has traded in a narrow band between 5,500 and 5,560. But all that is about to end – and the market action could get explosive.

Technical analysts watch this type of market very closely. They often see sideways action as a build-up of energy. They’re on alert for a significant move, as soon as the index closes below 5,500 or above 5,560, especially of trading volumes increase at the same time.

The reasoning is that buyers and sellers are meeting at the same market point. Eventually one of the groups will overwhelm the other, producing a significant move. The longer the bulls and bears are butting heads, the greater the build and the potential subsequent move. The daily picture is above.

At the bottom of the chart is the historic volatility – the rate at which the market is changing from closing price to closing price. After the Brexit inspired spike above 20% volatility has dropped away, despite some very large individual stock moves. This combination of highly volatile stocks and low volatility in the index points to investors maintaining their overall exposure to the share market. In other words, investors are rotating from stock to stock.

This is particularly important as volatility is at historic lows. Yes, you read that correctly. Despite the screeching headlines market volatility is at very low levels compared to long run averages. The chart below shows the Volatility Index for the Australian share market, since the ASX began calculating it in 2008. (Technical point – the VIX is a measure of the volatility implied by option prices, but tracks reasonably well against historic volatility).

The spikes above 60% (!!) on the left hand side of the chart are October and November of 2008, immediately following the collapse of Lehman Brothers. The dot at the right hand end is the month of August 2016. Not only is volatility low, it’s very steady at theses lower levels around 12%.

It’s this potential for a break out from the range and the current low levels of volatility that prompts some analysts to tip a large market move to come. Unfortunately, the chart gives no clues ahead of time about the direction of the move. This is the reason all investors should prepare. Large, unhedged portfolios are at risk from a market fall; those mainly in cash are exposed to a rapidly rising market.

What could spark the move? It’s important to note that many other markets are displaying similar characteristics, so a trigger could be local or international. By definition, unexpected events are not predictable, but there are two calendar events that have potential.

The world’s central bankers meet on Thursday and Friday this week at Jackson Hole, Wyoming. Some economists expect US Federal Reserve Chair Janet Yellen to ratchet up the rhetoric, and speak directly to a potential US rate rise as early as next month, or at least by the end of the year.

It is forecast this speech could occur on Friday night Australian time. US markets are at all-time highs, and a lift in rates could spook investors. On the other hand, investors may respond to the “signalling” aspect of such a move, buying on the back of Fed confidence about the US economy

Closer to home, most of the Australian companies yet to report half or full year results will do so this week. This is important, as fund managers tend to hold off on any portfolio changes until they’ve heard from most or all companies. This could see these large investors active next week, with potential for high market impact. A very good reason for all investors to pay close attention.