ASX Small Caps Break Higher | Episode 53

By Jason McIntosh | Published 22 July 2022

Trade the Trend is a weekly video focusing on where the stock market is going. It’s for investors and traders looking for insights to the market’s next move. Jason uses technical analysis of stocks and trend following techniques to help you piece together the world’s biggest puzzle.

Where is the Stock Market Going?

00:00 Intro

00:30 Why the ASX 200 is struggling to rally

02:43 ASX Small caps could outperform (watch for this)

09:34 Is gold ready to bounce?

Transcript (abridged)

Please note: Charts available from video

The ASX 200 has been one of the most resilient developed markets over the last six months. It’s held up better than the S&P 500 and better than the U.S. markets generally. But I think the scope for a rally in the ASX 200 at this stage is looking more muted than it is in the U.S. You see, the reason I say that is the dominant pattern on this chart is this big resistance band which comes in between $3,750 and $3,900. Picks up a couple of high points from over here in late 2020, early ’21, and it’s also got several low points over the last year or so.

And I think that just looking at the ASX 200 over the last few days, it hasn’t been able to rally, despite that positive lead from the U.S., it really hasn’t been able to make much headway into this heavy overhead resistance area. And unlike the S&P 500 and the NASDAQ, it hasn’t been able to close above its 50-day moving average. So this is a 50-day moving average coming through here. In the U.S., we’re seeing markets getting above their 50-day moving average. ASX 200 hasn’t been able to do that as yet.

So from that standpoint, I don’t think this market’s in a strong technical position. And if you’ve seen my video on the S&P 500, you know that I’ve been talking about potential for a further rally in the U.S. markets potentially over the next few weeks. And if the U.S. rallies, if the S&P 500 rallies, and, of course, this is going to naturally be a positive for the ASX 200 and it will probably rally as well, but I just can’t get excited about the technical setup that we’re currently looking at. It’s just not a market that I’m in a hurry to buy at this point.

But I will tell you about an area of the local market that is looking a bit more interesting. And it’s over here in the ASX small ordinaries. So unlike the ASX 200 that has held up relatively well over the last six months, the small ordinaries has been hit really hard. It was down at this point here in late June. It was down around 27% from the peak. So in about 6, 7 months, it fell 27%. And it looks a lot more like one of those U.S. indices than it does the ASX 200. I think a big factor driving this was probably, one, there was a whole lot of fear in the market, but also a lack of liquidity at the small to mid-cap part of the market probably also exacerbated this fall. But what we’re seeing now which is really interesting is that prices are breaking to the top side of this pattern that we have on the chart.

And now you may remember that I was talking about this last week. So this is a bearish… It’s called a bearish flagging formation. It’s similar to this one which we had back here in May. And this is typically how these patterns work out. You’ll have a decline, the market will slowly make its way higher in a rebound, and then it will break to the bottom of the pattern and have another hard selloff. That was what I was worried about last week when I was talking that the potential was the market would break out of this pattern. But what sometimes does occur is the breakout to the downside doesn’t happen and instead, you end up with this like a stepping sequence that breaks to the top side. And that’s what we’ve seen happen.

And it’s also closed above its 50-day moving average, which is another positive. And that hasn’t happened since back in April, so the last time the small ords closed above its 50-day moving averages back here in mid-April. And so what’s been interesting is that many of these smaller cap stocks have really been sold off heavily this year, much more so than the bigger stocks in the ASX 200. The ASX 200 has really been propped up by big resources and big banks. And as I was saying a moment ago, I think a lot of the decline was probably made worse due to a lack of liquidity in many of these small to mid-cap names. I know with my own portfolio when I was trying to sell some of my smaller cap stocks it just wasn’t much liquidity there. And then if you’re trying to move really large lines of stock that’s going to force the price down.

And I think this could now start to work in reverse and possibly fuel a larger bounce over the next few weeks. I think the small ords has…I think it’s got more upside potential here. And I actually did think about buying some ETF through the week. I was looking at the iShares small ords ETF. The ticket code is ISO. I ended up not doing that. I looked at long and hard, but in the end, I decided that I’d rather continue playing defensively. So, for me, the prospect of a bear market rally is… I think it’s just too much on the table that I didn’t want to play around the edges and try and get in early. But that said, there is a case for getting some exposure if that positioning is right for you, maybe as a medium to longer-term play.

And I think to keep this rally scenario in check, keep it in check, I think we want to see the small ords hold above this level through here, which is around $2,780 to $2,760. And that marks these two high points that we had from June and July. And what we want to see develop is a series of higher highs and higher lows which has started to develop through there. And now we want to see when this market pulls back, does it just pull back? Is it a shallow pullback followed by another high? That’s a positive price action that we want to see develop on this chart. And the next thing we want to see would be for these moving averages to start turning higher, and then for the 50-day moving average to get above the 100-day moving average.

But the thing which holds me back with this is that this could also be a longer period of base building which will be quite typical after a big decline. I don’t think we should necessarily expect that we get something like this, another V-shaped recovery which happened after the COVID period. They’re not typical recoveries. V-shapes do occur, but we’ve just had it during the COVID period. To get another one, I’m just not sure that’s what we’re likely to see. It could be more like a longer base developing over several months. And what that also does is when you get this longer sideways basing, it gives the moving averages time to stabilize and then start to turn higher. And that’s when you can get some good entry signals. So that’s more like the scenario that I’m probably favouring, but there is a play now for those who want to be a little bit more aggressive about approaching this market.

And what I want to do now, I’m going to have a quick look at gold, which has had an interesting week because what gold did during the week, it hit this support band down here at $1,680. So I was speaking about this support band a couple of weeks ago, and I think I’ve spoken about it probably a few months ago as well. It’s been a significant support level on this chart for a while.

And the thing with gold, it’s looking quite stretched below these moving averages. And often when a market gets stretched below the moving averages, it does snap back like what we saw here. It got stretched below the moving average and then we had the rebound. And so I don’t think we should be surprised if we see gold bounce off this over the next few weeks.

But that said, I don’t want to be buying just yet. For me, it’s too much a case of trying to pick the low. And I look at a lot of those gold stocks, those ASX gold stocks and it really is a case of going, “Well, I’ll just buy now and see what happens.” There’s not enough structural set up there to make me think now is a good risk-return opportunity to get in. But I do think this is going to be a great opportunity here at some point, and in commodities in general.

Also, in that copper space, I think there are some terrific opportunities which are going to develop there. But I just think we need to wait. I think we need to wait for the right setup. This looks like, to me, this whole period through here over the last year or so, it looks like a big consolidation. We had a big move up, we’re having a big sideways consolidation.

Ultimately, I think the odds favour that gold is going to break to the top side or break above these highs and head up to new higher levels. But like most things in the markets, it requires patience and not boldness. And I’ll have a closer look at gold when I start seeing signs we do have a base forming and we do have some signs that maybe we’re turning higher. I’ll be watching it closely. I’ll come back and look at it in more detail then.

Please see video for more detailed analysis and charts

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Meet Jason

I'm Jason McIntosh, the creator of Motion Trader. My career began in 1991 on the trading floor at Bankers Trust. Nowadays, I trade my own systems from home in Sydney. 
Motion Trader is for investors who value robust analysis, data driven entry and exit signals, commentary, and education. I use engineered algorithms to identify when to buy and sell ASX stocks. No biases or guesswork, just data driven signals.