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A pullback from unusual winter highs on the JSE top 40 index could still set up a base for a year-end rally

A pullback from unusual winter highs on the JSE top 40 index could still set up a base for a year-end rally

The JSE top 40 index has been trapped in a sideways range of between 42,000 and 49,000 for the past three years.

However, from the middle of June, the market rallied powerfully, resulting in the index gaining 10% in a straight line in just a few weeks.

The top 40 briefly pierced the 49,000 area and touched the magical 50,000 mark in the first week of August. But that breakout was met with profit taking, and a weekly reversal occurred, which brought the market back under the 49,000 level.

This suggests that the market may need to consolidate recent gains before making another concerted effort to break above the 49,000 area.

If a breakout above the three-year trading range is to have a decent chance of being sustained, it would be ideal if the market were to consolidate below 49,000 in a controlled fashion first. That would establish a higher base from which the market could attempt a breakout.

From a seasonal perspective, August and September are typically soft months for global equity markets.

Though the JSE hasn’t really followed its typical seasonal pattern so far this year, it is worth noting that the market has historically been weak in August, but that weakness typically sets up a rally into the end of the year.

The chart of the top 40 seasonality pattern looks at the average annual performance trend for the 20 years from 1996 to 2016.

What is clear is that the market is rather trendless during the middle months of the year, with August proving to be a low point in the winter months. The market typically trends more predictably from September to April.

In fact, the 20-year history of movements on the top 40 index shows that pretty much all gains are made in the months between September and April, with the four-month period from April to August yielding no return collectively over the past 20 years.

While the 20-year seasonal pattern is by no means a certain road map of how every year will perform, it is interesting to keep an eye on.

The top 40 index hasn’t really followed the seasonal pattern for the 2017 year to date, but if there is a pullback from the recent highs in the near term, that may nevertheless set up a base from which a year-end rally could ensue.

Overall the top 40 has been making higher lows and higher highs on each pullback in the year to date.

If that pattern continues, then it looks encouraging for a potential breakout beyond 49,000 in the months to come. This would open higher targets for the top 40.

In simple technical terms, an upside projection through 49,000 would be the height of the three-year range projected upwards from the breakout.

Given that the three-year range has been 7,000 points, a sustained break above 49,000 would open an upside projection to 56,000.

After three years of belowaverage performance on the JSE, a breakout to new highs would be a welcome reprieve for all investors.