Technical Analysis
Deeply Oversold Conditions
Last week we mentioned that the weekly had closed outside 2.5 standard deviations
and made the case for the possibility of a rally via mean reversion coming up. This
week we want to expand on this view, and will be contrasting the commodity complex
that is associated with economic growth (commodities are required for economic
expansion) with the STI. For uniformity of comparison, we are using 2 standard
deviations throughout.
STI Weekly, Weekly, October 2008
Last week we made the case that the STI has reached a historically oversold RSI
level. With readings at this level, and closes outside 2.5 standard deviations, we have
always seen some form of consolidation or reversion back to the mean in the coming
weeks. We continue to maintain this stand for the STI. This week we draw your
attention to the week of 11 July 2008, about 1 month prior to the major sell off in the
index. Our analysis this week uses an inter-market approach and we will be
contrasting the sell off in the STI with a top in the CRB Index.
CRB Index, Weekly, October 2008
Above is the chart of the CRB Index. The CRB is a composite index of grains, meats,
energy, as well as precious and industrial metals. From the chart above there are two
major points to take note of. Firstly, the CRB Index is also in severely oversold
territory with the weekly RSI trading at 23 and price closing outside 2.0 standard
deviations. This tells us that the probabilities lean towards mean reversion in the
weeks ahead.
The second point is that the CRB topped out on the week of 11 July 2008.
Commodities are associated with growth since raw materials are required for
construction and development of the economy. The week of 11 July 2008 is about
the time when we began to see the fears of a protracted recession creep into the
market.
Economic contraction bodes poorly for both commodities and corporate growth. We
can see this relation from the previous page where we saw the STI sell off very
sharply shortly together with the CRB Index after the CRB Index topped out.
STI-CRB Index Regression Analysis
To further reinforce our case, we ran a regression analysis of the STI and the CRB
index from the time of the market top in the CRB Index to today and found a very
tight correlation coefficient of 0.919. This shows both markets have been moving very
closely in tandem. We believe that this is due to the current market psychology that
believes a slowing global economy will bode poorly for commodity demand and the
equity markets as well.
The Big Picture
We have established that commodities are associated with economic growth, which
is the tied to corporate growth and the stock market. From this relationship, we argue
that the top and subsequent sell off in the CRB Index exacerbated the decline in the
equities market that was already in a bear market phase since October 2007. This is
clearly marked by the 11 July 2008 date when the dramatic drop in the STI over the
past 2 months came shortly after the top and subsequent sharp decline in the CRB
Index.
In the weekly charts, we are seeing deeply oversold conditions and a close outside 2
standard deviations for the CRB Index and the STI as well. Last week we made a
study of the STI during deep oversold conditions and observed that in the 'worst'
case, such conditions at very least precipitated a mild rally, and in the ‘best’ cases
when the oversold condition occurred during the latter end of the bear trend,
triggered a strong rally.
Oversold conditions for the CRB Index coincide with the current STI oversold
conditions and we feel that this skews the probabilities towards a coming bear market
rally in the coming weeks.
Select STI Component Stocks
The following section shows a few STI component stocks showing similar oversold
conditions.
Wilmar, Weekly, October 20082001
Wilmar has shown similar oversold conditions to the STI. Though it has not closed
outside 2 standard deviations like the index. It is a red flag worth taking note of for
those holding short positions.
Capitaland, Weekly, October 2008
Capitaland showing a mild close outside 2 standard deviations and a deeply oversold
condition.
Keppel Corp, Weekly, October 2008
Keppel Corp seems to be more deeply oversold with an RSI reading of 15 and as of
this writing is still outside of 2 standard deviations in the weekly charts.
City Developments, Weekly, October 2008
City Developments is not as oversold, but nonetheless had closed below an RSI
reading of 30 the week before and had a strong close outside 2 standard deviations.
Conclusion
We are seeing oversold RSI conditions and closes outside 2 standard deviations in
the weekly charts for the STI. This coincides with similar readings for the CRB Index.
We have also argued that the sharp sell off in the CRB Index had exacerbated the
decline in the STI (and global indices) and have also shown a very strong correlation
between them at this juncture.
As of now, the overstretched readings on the CRB Index seem to point towards at
least a move back within the standard deviation bands coming up in the next few
weeks for the CRB Index. Given that the sell off in commodities had amplified the sell
off in the STI and that both markets are currently trading very tightly with each other,
the reverse should hold true as well and a reversion to the mean in commodities
should help push equity prices higher.
Combine the relation between the CRB Index and STI with the STI's extreme price
readings, and we have the case for a possible rally coming up in the STI over the
next few weeks.
While our overall view of the market for the longer term is still bearish, do note that
the current decline has yet to be punctuated with any meaningful bear market rally or
consolidation. Bear market trends have very rarely gone straight down (except for
Black Monday) without some form of consolidation or correction. We believe this
trend is no exception and the current readings seem to be indicative that there is a
reasonable probability of at least a small rally coming up soon.
We advise readers to take some profits on the short positions they are holding and to
at very least, shift their stops down to a decent level of profit.
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