Yesterday, the Australia 200 index broke through resistance to post a new almost five year high. Valuation measures are a concern, but the purely technical view of a break out, combined with a volume surge and a closing price near the high of the day, point to the potential for further short term gains.
Here’s the big picture:
Australia 200 Index – Weekly
On this large scale the break out looks small – but it’s worth noting that yesterday’s close was almost 30 points above the break out level, giving more confidence that this is not a false signal. Whether using Fibonacci projections or a rough rule of thumb, many analysts come up with targets between 5,300 and 5,400. Given the strength of the break out, this could occur over the next few weeks.
The worry is that earnings have not kept pace with the index rise. At current levels, the index is trading at roughly 21 times 2013 earnings. While the market can maintain stretched valuation multiples for months or years, we are outside the “normal conditions” band between 12 and 20 times.
However, this may change with the current bank reporting season. ANZ’s result yesterday is likely to prompt upward earnings revision from analysts, especially if Westpac and NAB produce similar surprises. The big four banks now have a combine capitalisation of over $400 billion, meaning they now account for more than 25% of the Australia 200 index value. Upward revision of their earnings estimates could see the PE multiple drop to more comfortable levels.
The index dividend yield is lower at these levels – around 4.1% plus franking. This is still an interesting return in a 3% interest rate environment, but less compelling than previously.
Regardless, the price action clearly favours the upside. Given the valuation concerns, a stop loss below the break out level could be prudent. A possible set up to take advantage of the technical picture may look like: