MARKETS SPECTATOR: Pullback beginnings

With the market retreating late yesterday and Europe adding fuel to the fire overnight, it appears the inevitable pullback has arrived.

Over the last week or so, I’ve been warning that markets are due for a pullback as they have simply run too hard, too quickly and have found themselves in overbought conditions on a short term basis.

Well, it looks like the pullback has begun as the local market retreated yesterday after testing the 4950 level, and overnight we saw the ominous ‘eurozone concerns’ re-emerge after a month or two of hibernation.

As you can see in the chart below, the Euro STOXX 50 index was hit pretty hard overnight as political jitters in Spain and Italy saw bond yields surge while yields on German bunds retreated, indicating a little more fear is returning to the market.

This can be seen in the jump in the white Euro STOXX VIX (volatility) index, which is up about 25 per cent in recent weeks as investors look to hedge physical portfolio exposures.

We can also see that the S&P 500 has followed suit, although to a smaller extent at the moment.

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Having said that, I’m not concerned at all.

A pullback is a perfectly healthy and normal thing for markets and will bring it back into more of a balanced state. There always seems to be some sort of catalyst for these things and its very ironic that European headlines have reared their head again at the perfect time.

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In the above chart of the local S&P/ASX 200 index, we can see that the volatility index has risen as well, up more than 27 per cent from its low on January 16. Again, this indicates there is some buying interest among index options for portfolio hedging purposes.

So assuming I’m correct and we’re going to see a pullback over the coming weeks, the big question will be how deep it will be and when do we step in and ‘buy the dip’. Yesterday (MARKETS SPECTATOR: Pullback Poker, February 4), I wrote about why I think the pullback will be shallow.

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In the above chart of the S&P/ASX 200 index, we can see that the market has found some intraday buying support from the minor support level labelled. Given yesterday’s rejection of the 4950 level, I don’t think this minor support level will hold and further short-term profit taking will see the market pullback some more.

From a technical perspective, the obvious levels would be the psychologically important 4800 area, which coincides with the 23.6 per cent Fibonacci retracement, or the consolidation zone around the 4700 level.

We’ll just have to monitor it closely and hope we see a nice entry level in the coming weeks.