European Stocks Looking for Breakouts

03/12/2013 9:00 am EST

Focus: GLOBAL

Eoin Treacy

Global Strategist, Fullermoney.com

Despite Europe’s woes, there are some companies that have breakout potential, says Eoin Treacy of Fullermoney.

The S&P Europe 350 Dividend Aristocrats has underperformed the S&P 500 Dividend Aristocrats Index on both a nominal price and total return basis, despite the fact that it has a higher yield. The Index had become quite overextended relative to the 200-day moving average (MA) when it hit a new all-time high in July and spent much of the rest of the year consolidating. It found support in the region of the MA from November and reasserted the medium-term uptrend last week. A sustained move below 200 is the minimum required to question potential for additional upside.

Europe's economic difficulties have taken a toll on the ability of companies to sustain dividends. Of the 43 constituents, 26 are listed in the United Kingdom (UK). Only 11 are listed in the Eurozone, and most of those are listed in France.

A considerable number of constituents have been trending higher for a number of years and are becoming increasingly overextended relative to their trend means. Associated British Foods (ABF) and Intertek (IKTSF) (quality control) are representative of this group. If there is one natural law in the financial markets, it is that when something becomes wildly overextended relative to its trend mean, the situation is unsustainable beyond the short-term. Breaks in short-term progressions of higher reaction lows would confirm peaks of medium-term significance. However, until that occurs, the benefit of the doubt can be given to the upside.

I would rather focus on those shares that show long-term base formation completion characteristics.

Commercial Services provider, Serco (SRP) (consultancy/outsourcing) surged to test its 2008 peak earlier this week and will probably consolidate. But a sustained move below 550p would be required to question medium-term potential for additional upside.

Utility Centrica (CNA) (mostly gas distribution) hit a new five-year high in February, and the benefit of the doubt can be given to the upside, provided it holds its progression of higher reaction lows, currently near 340p.

Defense company Cobham (COB) has encountered resistance in the region of 240p on a number of occasions since 2009 and will need to sustain a move above 250p to confirm a return to medium-term demand dominance.

Retailer Colruyt (COLR) (discount supermarkets) has rallied to retest the €38 area and a sustained move above that level would bolster the medium-term bullish outlook.

Pharmaceutical firm GlaxoSmithKline (GSK) is retesting the 1500p level, and a sustained move above it would reaffirm medium-term demand dominance.

Chemicals company Johnson Matthey (JMAT) has been ranging, with an upward bias, above its previous peak for more than a year. A sustained move below 2000p would be required to question medium-term potential for a successful breakout.

Telecom provider Vodafone (VOD) is rallying from the lower side of a two-year range but a sustained move above 200p would be required to confirm a return to medium-term demand dominance.

In conclusion, there is the world of difference between an overbought condition following a breakout from a lengthy range and an overbought condition following an already well developed uptrend. We have long defined ranges as explosions waiting to happen. Therefore we anticipate powerful breakouts from well-defined trading ranges.

Since trading is often relatively condensed inside the range, a breakout will very quickly look overextended but can be given the benefit of the doubt until it stops posting a progression of higher reaction lows. In the case of something that is overbought following an already well developed bull run, the risk of a sharp pullback is more acute because bullish participation is higher and more leverage has been employed.

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