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Potential for more volatility

10.33 AEDT, Monday 25 February 2013

Potential for more volatility
By Ric Spooner (Chief Market Analyst, CMC Markets)

The rally in the Australian market since last November has been remarkable for its orderly progression and low volatility. However, investors are starting the new week conscious of the increasing risks that this behaviour pattern may change. Last Thursday’s high turnover, 2% decline provides an insight into the market’s potential for a sharp decline. There is now more potential for significant market moves in either direction.

The rally since November has been more about adjusting valuations to a lower risk; lower interest environment than improved earnings outlooks. The forward PE on the S&P/ASX 200 index has risen to about 15.25. Given the low yields on fixed interest investments, this is by no means an unreasonable multiple. On that basis there remains plenty of scope for market valuations to move even higher.

However, the forward PE is now well above the long term average. Thursday’s decline provides an insight into the scope for a sharp pullback if there is any change to the consensus outlook for a low rate; low risk environment.

The Italian election result and the outcome of Congressional negotiations on the automatic US budget cuts are the major risk events for this week. Both have the potential to influence consensus attitudes toward global risk. Australian markets are likely to remain relatively cautious before these events.

From a technical perspective, we begin the week with the uptrend intact. Thursday’s big drop was not enough to take us below the zone of support around the trend line that has defined the rally since November. Any break below the zone of support around 4973/4951 could indicate that a correction to this uptrend may finally be underway. This support is made up of the 20 day moving average and the early February peak. Last week’s high at 5106 represents initial, minor resistance.


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