UK shares have just broken through the top of a wide trading range after drifting sideways for 10 months. This breakout could be quite important for UK investors. History shows that breakouts following lengthy sideways drifts usually trigger strong continuation rallies. In other words, prospects for the rest of the year are potentially very positive.
Unfortunately, false breakouts occasionally happen as well. A good example occurred in early March when the banking panic temporarily drove shares down through the bottom of the range. We do not yet know if the current breakout will have any staying power so it is worth monitoring this trend very closely.
Should shares hold above the breakout point, I believe that investor psychology could significantly change. Current investors will be less inclined to flee from their positions during periods of stock market weakness. Sidelined money, on the other hand, will be more prone to treat dips as buying opportunities.
Although it is too early to make a final call on this breakout, my short-term view on stock market prospects for the rest of August is a positive one.
History shows that the second half of August is remarkably good to investors in bull market years. There were just five declines in the last few decades between August 17 and September 3. All but one occurred in a bear market. The trend is quite similar among large and small companies alike. In contrast, declines in bull markets are rare.
My own view is that a bull market is underway. If I am right, history signals that prospects for the next few weeks look good.
As far as my own trading is concerned, I continue to see signs that investors are snapping up shares in companies that are delivering weak first-half earnings. The market seems willing to ignore profit problems if it views them as short-term in nature.
Alumasc is a good example of the kind of company that I have in mind. It has excellent long-term potential but recent earnings reports disappointed investors.
As a result, its shares did not participate in the bull market that began in March.
Daily trading volume for Alumasc has been very low. Combined volume on the London Stock Exchange and Plus Markets averaged fewer than 4,000 shares per day in June and July.
But the trend just started to change. Average trading volume in August suddenly rose to around 20,000 per day, just as the low-volume holiday trading season arrived. This sudden increase in trading volume encouraged me to open a position.
Alumasc was originally a low-margined engineering company that produced commodity products. It converted itself into a high-margin producer in recent years via a string of acquisitions including Levolux (solar shading) and Blackdown (green roofing) – both growth areas.
The company is organised into two divisions. Building products offers premium-priced goods that emphasise sustainable energy. Revenues grew in the first half of the year in spite of tough economic conditions.
Engineering products, by contrast, is being hurt by difficult trading conditions in two important markets: automotive and canning. But investors forget that this division now accounts for less than 30 per cent of corporate revenue. Also, the company recently
made two announcements worth noting. It took £6m in costs out of the division at a one-off charge of just £800,000 and the level of recent customer inquiries
is higher than in many years.
On balance, I think the profit problems in this division are being resolved. A dividend yield of more than 10 per cent will probably help to support the share price, even if progress is slow.
My price chart shows that several powerful bounces have recently occurred when shares came in contact with the support line. Prices currently sit very close to support. The situation is now ripe for a healthy bounce. Recent increases in daily volume suggest that other investors have similar thoughts.
Stock market historian David Schwartz is an active short-term trader writing about his own trades and strategies. Send any comments or suggestions to tradersdiary@ft.com
