A BULL IN THE WINGS - SELECTIVE CONTRARIAN BUYING OPPORTUNITIES

EXECUTIVE SUMMARY
WEEKLY CHART OF ALL SHARE PRICE INDEX

The short term technical picture of the ASI clearly shows a market that is trending down and it would not be unreasonable to see 5900-5950 levels being tested. However, we th have seen of the 4 wave (of a typical five wave) downward leg and therefore we feel the market is close to a short term bottom at 5950 levels. Sentiment is extremely poor and even though the market is oversold, it is of no use to recommend selling at these levels as the time for liquidation and profit taking is well past due as the market has dropped almost 600 points from its peak of 6528 in May 2013.The likely worst case scenario for wave 5 on this decline would be around 5900 levels. The technical configuration remains negative as long as prices remain below the resistance and prior pivot high of 6165 nd (reached on 2 July 2013). A trend line dating from the December 2012 low of 5327 could provide support at 6000 levels. In addition to 6000 being a psychologically important level, we also have a major pivot high of 5895 from January 2013 providing support. The key point is that the evidence (i.e. oversold technical measures, wave analysis, and extreme bearish sentiment) suggests that the market is ripe for an upward reversal. The market is in the latter stages of this decline and we recommend looking at stocks such as JKH (LKR 240), TJL (LKR 12.4) and GLAS (LKR 6.3) as potential short term buying opportunities. From a 1-2 year point of view, CALPs technical interpretation of the All Share Price Index is positive as long as the June 2012 pivot low of 4725 is not broken. The 4725 level is the pivot low that was seen after the decline we witnessed from the 2011 high of 7800. It is essential that the stock market stay above this level in order to keep its long term uptrend alive.

CAL Securities Level 5, Millennium House, No.46/58, Nawam Mawatha, Colombo 2 Tel: +94 11 231 7778 Email: vimal@capitalalliance.lk Technical Analyst Vimal Ramchandani

See page 9 for important disclaimer mportant disclaimer

We strongly urge investors to be selective in stock picking in the months ahead due to a softer global tone and the unwinding of foreign fund equity and currency carry-trades in th the Asia-Pacific region. Once the 5 wave of this decline concludes, we will have a bull waiting in the wings.

MARCH-JUNE REVIEW In our previous update in March we had stated that the ASI was hovering around significant support at 5600. We went on to write that this level is important as it signifies prior resistance turned support (neckline of the inverted head and shoulder) and it is a 50% retracement of the entire December 2012 rally. We also mentioned that the market would turn bullish if the 6000 level was overcome. Between March and May, the market had tested 5600 support level successfully, broke 6000 and rallied approximately 16% to 6500 levels towards the end of May 2013. We will clarify in the next section as to why the index stopped its ascent at this particular level and what to expect going forward. From the high seen in May, investors have been selling the Sri Lanka market and it is currently down approximately 7% at 6000 levels.

WHY THE MARKET FELL IN JUNE Liquidity injected by major central banks, that is, the Fed, European Central Bank, Bank of England and, recently, Bank of Japan have been the major driver of equities around the world. Some investment funds flows have found their way into frontier markets like Sri Lanka searching for higher returns. However, the gradual recovery of the worlds largest economy which is now compelling the Fed to possibly reduce its QE actions may not be positive for frontier markets. While tapering and the ultimate end of the current ultra-loose monetary policy by the Fed may not be imminent, Sri Lanka has felt the impact of the news. Foreign inflow, both into equities and fixed income have slowed down and we have actually started to witness some redemptions by foreigners. In fact, net foreign inflows have reduced by approximately 70% between May (LKR 4.9 billion) and June 2013 (LKR 1.5 billion). Reduced inflows may cause the Sri Lankan rupee to depreciate further (Please refer Figure 1). Low foreign investor participation in the local bourse may also signal further selling pressure as domestic investors, including institutional players, are not liquid enough to drive the market on their own. Beside these factors affecting the market, a big reason for the market decline in the past month has been the fall of John Keells Holdings (JKH, LKR 240). This stock constitutes 9.2 % of the index (largest stock) and has seen its stock price fall from LKR 299.8 to LKR 240 (approximately 20%). Compared with the rise of the ASI, JKH had moved up significantly by approximately 29% between March 2

& April, making it very vulnerable to a correction from a technical and fundamental point of view. CAL Researchs fair value for JKH is LKR 210 (+10% for liquidity). Commercial Bank (COMB), the biggest bank by market capitalization has seen its value fall by approximately 10% from its May high of LKR 126 which has added to the downward pressure on the index. We will discuss the technical picture for both these stocks and their effect on the overall stock market in detail. (See pages 6-8) We can see from Figure 1 below, that the Sri Lankan rupee broke the down trend line signaling weakening of the rupee in May 2013 and since then, there has been a sharp depreciation against the dollar. This has coincided with the decline in the stock market and confirmed its relationship to the stock market. LKR 130 is an important resistance for the rupee. However, should there be a convincing break above it, the rupee could easily test 2012 lows of LKR 134.
FIGURE 1 DAILY CHART USD/LKR

MARKET ANALYSIS Please refer to Figure 2 below The CALP technical team views the recent price action from (June 2012 to May 2013) as a corrective phase within a larger downtrend that started in February 2011. The high at 6528 (28th May 2013) is a significant top. We did not need the fundamental rationale mentioned above to become bearish on the market in May. There were 3 main technical reasons for a top at this level.

We can clearly see an ABC corrective wave, otherwise known as a zigzag where WAVE A is equal to WAVE C in magnitude. This level is also significant because it proved to be former support, now resistance for the index between December 2010 and October 2011. The 6500 level is very close to the 61.8 Fibonacci retracement level of the entire decline between February 2011 and June 2012.

Figure 2 also depicts short term support between 6000 and the January 2013 highs at 5900. The downside risk implied by the break of this support is 5600 (12th March 2013 low).

FIGURE 2 - WEEKLY CHART OF THE ALL SHARE PRICE INDEX

As shown below in Figure 3, trend line support and Fibonacci extensions point to levels of support between 5870 and 6000. It is of little use to use momentum indicators like RSI and MACD as the market can stay more oversold than we can stay solvent. Either way, taking reward and risk into consideration, the technical team feels a recovery in risk appetite appears imminent as the supply of nearterm negativity that has convincingly unhinged markets could start drying up.

FIGURE 3 - INTRADAY CHART OF ALL SHARE PRICE INDEX

WHAT TO EXPECT Please refer to Figure 4 (below). Wave analysis suggests that once the 5th wave of this decline is complete we expect a 3 wave corrective bounce in the index to at least 6200 levels which is approximately 38.2% retracement of the entire decline from May 2013 highs. This should be viewed as a countertrend rally and a reason to sell as the market would likely start a fresh 5 wave move to the downside that targets critical support at 5600. This is only a theory at the moment as we always strive to identify the market activity that will invalidate our opinion of the market position at any given point in time.

FIGURE 4 DAILY CHART OF ALL SHARE PRICE INDEX

JOHN KEELLS HOLDINGS If JKH gets the sniffles, the market gets influenza Please refer to Figure 5 below. After testing the psychologically important level of LKR 300 and being extremely overbought at that stage, JKH has seen a very steep correction that has had a very significant effect on the overall state of the market. After testing LKR 250 successfully, which happens to be exactly 50% Fibonacci retracement of the rally that started in October 2012, JKH continues to make lower lows and lower highs. This downtrend has extended to about LKR 240 levels where you will see trend line support and a 200 day moving average. Until JKH breaks above LKR 270 (prior pivot high) and changes the character of its downtrend, it is advised to sell any rally that takes place. Please note that it took JKH almost 3 years to break above LKR 230 and so we expect there to be decent buying support for this stock at LKR 230 levels. It would not be a bad idea at all to open trading positions if JKH were to test these levels.
FIGURE 5 JKH DAILY PRICE CHART

COMMERCIAL BANK Harbinger for banking sector correction? Please refer to Figure 6 on the next page - Commercial Bank lies at very precarious position just above LKR 112. The chart clearly shows a head & shoulders formation (bearish) but we still do NOT have confirmation until the neckline at LKR 112.2 is broken convincingly on a closing basis. Possible targets are LKR 108-109 and then LKR 105 levels. Until you see LKR 118 (prior pivot high) broken on a closing basis, we advise selling any short term rallies.
FIGURE 6 COMMERCIAL BANK DAILY CHART

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