Further upside room for KLCI

Investors should be prepared for market volatility to remain high and only look to buy on sharp dips and sell into rallies

A WINDOW-DRESSING attempt in the local stock market last week was overshadowed by extreme external volatility, as the unexpected rejection by the US Senate of the US$14 billion bailout plan for American carmakers late week increased fears that the global economic downturn will worsen.

Nevertheless, the benchmark Kuala Lumpur Composite Index (KLCI) still gained 13.99 points, or 1.7 per cent week-on-week to close at 852.27, as daily average trading volume improved to 420.9 million shares from 360.5 million shares in the previous week.

The recessionary fears are not without merit as the US is a major export market for all world key trading nations and any slump in its consumption power will affect the rest of the world. For instance, the US is China's single largest importer. The fact that China's exports contracted for the first time in seven years last November is worrying but worse is the import figure that showed a much greater contraction. Malaysia was not spared as its October Industrial Production Index released last week revealed a higher-than-expected contraction due to softness in all three sectors that it measures, namely manufacturing, mining and electricity.

So, there could be a relief rally in Asian markets this week as a response to the US government's willingness to provide short-term aide to its carmakers from the US$ 700 billion allocated for financial firms under the Troubled Asset Relief Programme. This quick about-turn was deemed necessary to prevent the US car industry from collapsing and dragging along the economy into its worst recession since the Great Depression.

The October manufacturing sales and November Consumer Price Index numbers for Malaysia will be released on Friday. The CPI is expected to show further easing and the slew of downward adjustment in pump prices will help to push the index lower to the 2.0-2.5 per cent range in 2009 after hitting an expected 5.6 per cent this year. This will provide room for further monetary loosening and the central bank could slash the Overnight Policy Rate (OPR) as much as 75 basis points next year to accommodate economic growth.

Talking about pump prices, in the wake of continued weakness in crude oil prices, anticipation is building up for the government to release its proposed mechanism to determine fuel prices which the relevant ministry said will be brought to the Cabinet's attention this week.

Based on BP's Statistical Review of World Energy 2008, Malaysians consumed 514,000 barrels of oil per day in 2007. That works out to be close to 30 billion litres a year. This implies that every 10 sen reduction in pump prices will result in a RM3 billion increase in disposable income. Taking into consideration that only 65 per cent of the development expenditure for 2008 has been spent so far (based on available information) and that it may take a while to execute the RM53.7 billion development allocation for 2009 apart from the RM7 billion announced under the stimulus plan, it would be worthwhile to consider cutting pump prices further to increase disposable income of Malaysians and stimulate consumption.

Year-end window dressing attempts are expected to continue this week amid strong local institutional buying. Nevertheless, as market volatility is expected to remain, stick to the "buy on dip and sell on rally" mentality.

Technical outlook

The local market failed to sustain an early boost from a two-day rally in US stocks on Tuesday after investors returned from the extended weekend break, as foreign selling coupled with falls in the region due to earnings concerns dragged the KLCI down to close at the week's low of 835.17. However, the index enjoyed a strong 19.5 points or 2.3 per cent rally the next day fuelled by rallies in Asian markets.

While gains extended into Thursday on light window-dressing activities which lifted the KLCI to close at a seven-day high of 860.68, sellers returned to depress stocks ahead of the weekend on news that the US Senate failed to pass the US carmakers bailout plan, causing Asian markets to plunge. However, lower liners in the local market were relatively unscathed.

The daily slow stochastic indicator for the KLCI has reversed to trigger a buy signal following Wednesday's rally (Chart 1), while the weekly indicator sustained its bullish signal. However, the 14-day Relative Strength Index (RSI) hooked down due to last Friday's sharp dip, but the 14-week RSI hooked up to indicate firmer trend ahead.

The daily Moving Average Convergence Divergence (MACD) trend indicator supported the bullish stance on weekly momentum indicators after its signal line expanded higher, while the weekly MACD is staging an initial hook up which suggests improving upside potential. Meantime, the downtrend signal on 14-day Directional Movement Index (DMI) trend indicator has weakened further with the ADX line descending to a reading of 36, implying the downtrend from January this year may be in the final stage, or the market is bottoming out.

Conclusion

As technical momentum and trend indicators for the KLCI have improved significantly following last week's gain, there should be further upside room for the index this week. Nevertheless, it will need to stage a decisive breakout above last week's high of 860 and 864, which represents the 50 per cent Fibonacci Retracement (FR) of the bear market rally from the 801 pivot low of October 28 to the 926 high of November 5, to extend upside towards 870, which mirror the levelling 30-day SMA. Expect stronger resistance at 879, the 38.2 per cent FR, with 888, representing the 23.6 per cent FR of the plunge from the pivot high of 1,164 on July 31 to the 801 pivot low and also the upper Bollinger band, to acting as formidable upside hurdle. Meantime, immediate support is seen at 849, the 61.8 per cent FR level, with last week's low of 835 and 830, the 76.4 per cent FR last critical support level, acting as strong downside cushion.

On the external front, given the resilient US stocks last Friday which benefited from the assurance by the US Treasury that it will help push through the car bailout plan, stock markets in Asia should again reverse some of last Friday's heavy losses as optimism return that there is still light at the end of the tunnel for the US economy, despite the extremely bleak outlook for next year.

Nevertheless, investors should be prepared for market volatility to remain high and only look to buy on sharp dips and sell into rallies as gains will be tempered by bleak economic and earnings outlook in the immediate term.

The subject expressed above is based purely on technical analysis and opinions of the writer. It is not a solicitation to buy or sell.