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Here are two ways Australia's 'stout' and 'tubby' stock market could play out

Photo by Scott Gries/Getty Images

Australian stocks have been under pressure for the past seven months. But they have traded in a wide range as each sell-off has found some investors willing to buy the market back off its lows.

That, according to Evan Lucas, market strategist at IG in Melbourne, means “the ASX’s 2016 path has a distinctly ‘tubby’ and ‘squat’ profile – a historically wider trading range (tubbiness) with relatively low aggregated capital growth (squatness)”.

The source of the volatile price action, Lucas says, has been “the Chinese devaluation in August has seen this ‘stout’ and ‘tubby’ strategy becoming ingrained as the short term norm”.

Some traders will love that because tubby and squat mean the market is trading in a range where in which they can buy and sell at either extreme. But other traders will find the constant to-ing and fro-ing a difficult trading environment.

Lucas suggests there are two possible resolutions to the current environment here and on global markets.

    1. Markets (ASX included) will collapse and become fundamentally ‘cheap’ – the six and half year bull market only ended six months ago, the correction in January had distinct characteristics of being overvalued in the current cycle and is looking for structural weakness.

    2. Markets will remain volatile and trade in a directionless manner with a tubby and stout 2016 profile. Macroeconomic fundamentals, the oil price and inflation will leave markets in a state of flux if it doesn’t break down.

Lucas says that on the basis of a combination of enduring macro fears, earnings that are ahead of market expectations but still down half on half, and continuing concerns about fear in the banking and material sectors means that our tubby market is likely to stay that way.

But he has a very strong warning that the market is not yet cheap (our emphasis):

My strategy for the ASX is trading a ‘tubby’ and ‘stout’ movement with a possible capitulation trade as the end game. A break below the February 10 level means that ASX is moving towards its ‘fundamentally cheap price’, however it’s more likely it will range trade until the end of the financial year.

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