MARKETS SPECTATOR: Taking profit

In overnight action, US markets finally succumbed to some healthy profit taking after last week's announcement of QE3 had lifted the major indices to multi-year highs. On top of that, the Empire State Manufacturing Index came in below expectations, which added to the selling pressure. All three of benchmark indices were lower by 0.2 per cent after being down as much as 0.6 per cent before a late session bounce.

Outside of the manufacturing report, everyone quickly looked for a big reason as to why the markets retreated. The fact of the matter is that that markets ebb and flow, much like the tide comes in and out. There had been a strong rally since the announcement of QE3 on Friday and it simply looks like some traders have decided its time to book some profit.

So looking ahead to the Australian session and we should see much of the same pattern play out. The S&P/ASX 200 SPI futures finished flat in overnight trade and are pointing towards an open just south of the psychologically important 4000 figure, around 4397. However, with the weakness seen in commodity markets and stocks overnight there is probably some downside risk to this opening level.

Unsurprisingly, it was the cyclical sectors which have rallied so hard that led the pullback overnight; there's no reason to believe it will be any different in Australian trade. With the US basic materials sector sliding 1 per cent in overnight action and commodity prices broadly weaker, expect to see the bulk of the profit taking in the materials sector.

After a decline of 1.2 per cent in UK trade and with BHP Billiton ADRs down 1.4 per cent in New York, it looks like the diversified giant will lead the sector and market lower this morning. Outside of nickel, base metals on the London Metals Exchange all saw profit taking, down between 0.5 per cent and 1.5 per cent; these moves will add further pressure to the sector.

The much discussed iron ore prices actually managed to buck the trend overnight, rising another 3.3 per cent to 105.1 US/t. At least there could be a little respite for the underfire iron ore plays, although all eyes will firmly be on Fortescue Metals Group and what they have to say before resuming trade at 1000 AEST.

As I wrote yesterday (Market Spectator: Gearing up for materials gains, September 17), the materials sector has made a big push higher in the last week and broken out from its recent trading range and downtrend. Many traders would have struggled to find a reasonable entry point into these fast-moving stocks, so expect to see plenty of participants willing to step up to the plate on the dip.

Judging by offshore leads, there's likely to be some weakness among banking names too after US financials saw profit taking as well. More specifically, there will likely be continued focus on the domestic retailers ahead of David Jones result due for release tomorrow. The stock was down more than 2 per cent yesterday, indicating traders are pretty nervous about what the upmarket retailer might unveil.

Domestically, the only economic news due for release during the trading day is the RBA Monetary Policy Meeting Minutes due at 1130 AEST; this doesn't usually have a big impact on equities but can do so in currency markets if there is a significant change in the tone of the statement. As it stands, not much change is expected in the this morning's release. The only other event of note will be a speech by RBA Assistant Governor Debelle at 1300 AEST; once again these speeches don't usually move the markets.

So all in all, it looks like a weaker start to the Australian session as traders look to book profits following the recent rally. However, don't be surprised to see the market well supported on the dip as many participants will be looking to ‘buy the pullback'.