MARKETS SPECTATOR: Sit out the short-term

The Australian market is approaching a major resistance zone, so for those wanting to enter into the ongoing rally the prudent move would be to wait out the pullback.

If the S&P/ASX 200 manages to close in the black today, it will be the 10th straight gain for the benchmark index and the best run since October 2003.

The chart is quite incredible; normally markets don’t move in straight lines but it’s basically been straight up since the mid-November lows. In 2½ months, the market could only manage two consecutive losses.

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Source: Iress

In the above chart, we can see that a major resistance zone is just around the corner. This resistance zone roughly corresponds to the all-time high resistance levels that both the S&P 500 and Dow Jones Industrial Average are approaching.

I think it is highly likely that we get some sort of profit taking/pullback/consolidation reaction at or around these resistance zones. It’s entirely natural and healthy for a market to pullback or consolidate after such an incredibly strong rally.

While I remain firmly in the bullish camp in the medium and long-term, I’m beginning to wonder about the risk/return pay-off of entering the market following such a strong short-term rally. Equity markets are approaching severely overbought levels on many different metrics and in my mind there is nothing surer than a pullback of some sort.

We’ve also reached a point where bullishness is beginning to dominate newspaper headlines, which is like waving a red flag in front of a, well, bull.

From a risk/reward perspective, I think the equation has changed for those investors who have yet to enter the market.

When the market is running hot, one of the hardest things to do is wait patiently for a pullback. The fear of missing out (FOMO, greed) is an incredibly powerful emotion. At these levels and given the recent performance, I think the prudent thing to do is to patiently wait for a pullback.

I think a lot of ‘mum and dad’ investors could easily get sucked into the buying the market at these levels just before a pullback/correction begins.

Don’t get me wrong, I certainly wouldn’t be shorting the market in anticipation of a big sell-off. Rather, for those who have yet to jump in I would simply wait until we see the inevitable pullback rather than buying when the risk/reward scenario favours a consolidation period.

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