Tuesday, January 17, 2012

JSE Top 40 - Long-run Technicals Seem to Point to a Fall

In one of my previous posts I looked at how much value we can buy with one share of the JSE Top 40 Index. The numbers I ran seem to suggest that while index prices were going up, the value we're able to buy is trending down. This is bad for stocks, but understandable due to the high prices of commodities.  

For today's posting I decided to open the technical analysis/charting toolbox again, this time considering the JSE Top 40 index. What does the technical chart suggest? It suggests that the local market may be heading for a downturn. 

Just to be clear, this is not set in stone.  Technical analysis is not always right, and there is much debate on whether it works. I like to look at technical charts in context of the market fundamentals.  

So what do we know about the markets at this point? Here are some things to consider. 

1) The Eurozone is in trouble ...
2) The US expanded its M1 money supply from about 800 billion to about 2.4 trillion USD since 2008, basically keeping their economy alive on debt... this makes high inflation very likely.  
3) US debt burden is massive; see US debt visualized
4) Global GDP growth appears to be slow ...
5) Commodities showed strong growth and money follows growth ...  

Technicals suggest a crash is likely ...

With that out of the way, let's consider the following Technical monthly chart of the JSE Top 40 Index.  I applied a long term Moving Average Diversion Conversion Indicator (MACD - basically an indicator that measures momentum - the strength of a market uptrend or downtrend):

Click to expand
Remember, we are only considering a technical chart for information on probable market moves. Some things are evident: The index has tested the current resistance level, the highest red diagonal line, (a price ceiling) for some time and is trading in a trading range, between current support and current resistance lines.

The Crash of 2008

Consider the descriptive comments on the MACD indicator before the crash of 2008. It is likely that the previous strong bull run (an upward market move) started in 1998 and gained momentum in 2003 after a short consolidation (look for the red downward pointing arrow below the label "bull market 03 -08" on the chart.

Consider what the Top 40 Index did at the arrow labeled with "Crash! 08". Most certainly we all remember what happened in 2008 when the market crashed, crazy times.

Important to look for is the cross over of the black line over the blue line in a downward direction on the MACD indicator (The crossover occurs at the arrow labeled with "MACD Bearish Signal!"). Such MACD crossovers are commonly regarded as signals of a changing market movement.

The market confirmed the indicator with the recession of 2008 where the index lost a lot of points.

MACD Bullish Signal and Price Recovery

The chart suggests that the price recovery and upward trend started in Mid 2008. Notice that the MACD confirmed the recovery and upward trend with another crossover; where the black line of the MACD crossed over the blue line in an upward direction.

Current MACD Bearish Signal

At the end of 2011 the MACD experienced another MACD crossover (look for "MACD Bearish Signal NB!'). This crossover suggests that a strong and lengthy downward move is probable.

Historic support levels are indicated on the chart at Support 1 and Support 2 (there is another potential support level at around 23000 points not indicated on the chart). Support levels are like mattresses that break the fall; these are levels in the market where bottom buyers are expected to halt the decline of prices. In the 2008 crash the market found support at the level denoted by the label "Support 1".

If/when we experience the next big downtrend; I expect the market to find support at either around 23000 points (best case scenario); Support Level 1;  or support level 2 (worst case scenario). Such moves would entail massive losses.


So, the technical chart, I considered, shows that it is probable for the market to experience a crash in the long run. Since Technical Analysis is not always correct, I decided to do some additional research on the Top 40 Index.  I considered historic PE ratios and earnings, I'll cover these in my next posting.

Read my next post to see what that research suggests.

Any thoughts or comments, please share below.

Posted by Gerhard van Onselen (follow me on Linked In and Twitter)


I am not a professional financial adviser. Information presented is intended to be solely conversational and educational, please don't make investment decisions based on just one source, do your own research, and consult a registered financial adviser.

While I tried my best to present accurate information and numbers in this posting, I cannot guarantee the accuracy of any information presented.   

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