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Market defined by international events

10.05 AEST, Monday 10 September 2012

Market defined by international events
By Ric Spooner (Chief Market Analyst, CMC Markets)

The ruling by Germany’s court on the constitutional validity of the European bailout fund and the Fed’s decision on additional monetary stimulus will be the defining events for markets this week.

Investors are likely to stay cautious prior to the German court decision. The ECB’s plan to buy Spanish and Italian bonds has removed a major source of short term risk for markets. However, the ECB plan is dependent on the bailout funds being effective. A negative decision by the court could be a significant source of uncertainty for markets.

This could unwind some of the increase in share market valuations that have occurred since Mr Draghi’s initial “whatever it takes” statement in early August. If the court decision is negative, investors will reduce risk exposure until they see details of alternative plans.

Friday’s weaker than expected US employment growth figure now makes easing by the US Federal Reserve Board likely at the end of this week. Markets have already adjusted for this. However, the size and nature of the Fed’s actions will be important for asset valuations including shares and commodities. There is still significant upside potential if the Fed is surprised with a large “bazooka” style initiative.

The response to Friday’s stimulus announcement by China may be more muted given that China is still in the relatively early stages of its easing cycle. Markets will be encouraged by the intent demonstrated by Friday’s $160 billion infrastructure spending announcement and by President Hu’s weekend statement that China will act to maintain steady growth. However, as the decline in China’s share market and of key commodities prices like coal and iron ore over recent months demonstrate, the early stages of easing cycles are typically bearish. Economies and corporate profit growth are weakening and the benefits of stimulus measures like infrastructure spending are lagged.

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In technical terms, trend line resistance around 4475 remains a key hurdle for the S&P/ASX 200 index. A clear break above this level would be an indicator that investors are prepared to reduce risk premium and buy stocks at higher forward PE valuations than we have seen for over a year. A good result from the German Court and decisive action by the Fed could see a test of this resistance.

Looking at the flip side, there is a zone of support around the 200 day moving average at 4216. A move under this could be taken as a sign of a clear retreat into the more cautious investor attitudes we experienced earlier in the year.


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