The selloff in global equity benchmarks has been swift and punishing for long only investors as asset reallocation comes after the hangover of accommodative monetary policy. Australia in particular has not been immune from these developments, between dealing with a downturn in trade across the Asia-Pacific region and softer commodity prices. Aside from external factors, domestically, uneven growth and slowing inflation have seen the Reserve Bank of Australia ease policy multiple times in an effort to make conditions more attractive and insulate the region. However, as evidenced by the reaction in the Australian ASX 200 over the last week, global conditions and sentiment remain a key driver of momentum. With circumstances only set to worsen, the bearish outlook facing the Australian ASX will likely prevail over the medium-term.

Dragged Down By Financials

The Australian ASX has had a tough weak as negative sentiment crept across the globe following the rout in the European banking sector on Monday. The rest of the global banking sector has fallen in solidarity as evidenced by the weakness in systemically important financial institutions across the world. Australia was no different in this respect, especially considering that the stocks with the four highest weightings in the ASX 200 are from the banking sector including Commonwealth Bank of Australia (9.32%), Westpac Banking Corporation (7.23%), National Australia Bank (4.98%), and Australia and New Zealand Banking Group (4.98%). Together they comprise approximately 25% of the total weighting, meaning any negative momentum is likely to drag on the entire index lower.

Even though the weakness in the Australian dollar should provide a degree of tailwinds for the local stocks by making them cheaper on a relative basis, so far no such benefit has been derived as evidenced by the recent price action. On the whole, part of the recent weakness in the benchmark can be derived from the fundamental conditions prevailing across Australia and the Asia-Pacific region. However, strong domestic spending conditions continue to prop up the economy in light of losses in exports. Overnight, the ASX 200 index managed to bounce moderately, climbing by 0.78% after 149 stocks out of the entire 200 comprising the index fell rose, with Cochlear Limited leading the gains, rising 13.73%% in trading.

Bank stocks are still trading mixed, with Commonwealth Bank remaining in negative territory over the session while other major banks are rebounding. Even though the region’s largest bank reported stellar earnings and maintained its shareholder dividend, it remains susceptible to global financial services contagion fears. Also hurting is the resources sector with commodities continuing their slide and companies forced to slash costs further. Adding to the risks for the index is the surge in downgrades to the earnings outlook for components. With many investors shifting away from yield and back towards quality in an effort to preserve capital, market participants are not seeking gains as much as the safe return of principal.

Technically Speaking

After reaching the lowest levels since 2013 back on the 10th, the Australian ASX 200 looks poised to continue the existing downtrend after officially entering a bear market. While the index is starting to look slightly oversold following the widespread global sell-off, downward signals are largely intact. On the one-day candlestick chart, the descending triangle formation setting up since the summer months is seeing key support at 4755 being tested although not broken. The triangle pattern which is formed by the price consolidation between an existing downtrend and horizontal support level is typically viewed as a breakout trading opportunity. While trading the consolidation can have risks because of narrowing reward and higher risks, a breakout to the downside provides traders with immense opportunity to capitalize on downward momentum.

Despite the potential for the modest correction higher to continue, most technical indicators are pointing to a sustained bearish run. Aside from the descending triangle pattern, both the moving averages are confirming the bias lower with the 50 and 200-day moving averages both trending lower. On the immediate upside, the 50-day moving average will act as resistance against any prolonged pullback higher in the ASX 200. Adding to the downside case is the “death cross” signal that came back in July after the 50-day moving average crossed the 200-day moving average to the downside in a notoriously bearish indication. Should the ASX 200 break down from current levels and move below prevailing support, it opens the door for a sustained movement towards 2013 lows near 4600.

Takeaways

Owing to the fact that the financial and resources sector probably have further room to fall and their relative weighting in the ASX 200 index, positive momentum higher is likely to remain elusive especially after the index recently entered a bear market. In spite of ongoing efforts by the Central Bank to keep the economy resilient from both internal and external developments, the weak backdrop remains a concern for investors, with the index matching global momentum. Considering the fundamental outlook and the growing bearish bias signaled by technical indicators, any rebound such as the price action from overnight should be taken as an opportunity to establish positions targeting multi-year lows in the Australian ASX 200 benchmark.

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