Outperforming The S&P By More Than 20%
Let’s
take a quick look at the top RS sectors of the global equity markets
since the March lows that launched this mini-bull market cycle. The top gainers
so far have been Gold stocks, Resource stocks, Brazil, Networking, small cap
Japan, semiconductors, China, Eastern Europe/Russia, Emerging Markets, Latin
America, South Africa, Asia, Technology, Commodity Currency Countries, and Small
Cap Value. We have mentioned in this column investments in gold, resources,
small cap Japan, China, Eastern Europe, Latin America, South Africa, Asia, commodity
currencies, and small cap value. All of these sectors have outperformed the
S&P by more than 20% at their RS highs.
Ones that still look pretty
strong technically now include gold shares, commodity currency countries, South
Africa, and Small Cap value, while Resources and Latin America are questionably
OK, but are in at least a minor correction. And that means that much of the
leadership of this mini-bull move, is starting to experience some turbulence.
This is in line with the shift in the fuel of the bull market that we have been
discussing for weeks. Investors should become more cautious here than they have
been since the March-April bottom and buy signals. Take some profits and tighten
stops — yet look to re-enter upon re-emergence of relative strength by
the leadership above that still look most promising. This does not include technology
and network, which have become too pricey, or Eastern Europe, which has become
overvalued vs. the rest of EMs and have expensive currencies, plus the anchor
of poor European growth.
Based on normal cyclical
measures, there has been a massive enough spray of liquidity both fiscal and
monetary around the globe that this recovery should become self-sustaining and
inflationary pressure would be the common end-game sometime in late 2004-2005.
Yet mini manias fueled by massive liquidity are not your average cycle —
and that means investors should exercise more caution than usual.
Increased terrorism, threats
of a trade war starting with China, and other political and global backdrops
remain a concern that could dampen enthusiasm. Markets have become overbought
and sentiment has deteriorated from an excessive level. Insider sell ratios
are off the charts, but often way early. The Utility averages and net new highs
both peaked around five months ago, and normally lead to 6-12 months.
Thus, our base scenario
of a cyclical bull market in progress, being punctuated by a transition from
liquidity-led recovery to profit-led recovery that usually leads to a 10%+ correction,
remains the most likely one we can see ahead. Whether that correction has already
begun or will begin soon, remains to be seen. But taking some profits and tightening
stops appears reasonable.
And don’t forget how
critical it is for investors to watch global bonds (broad new lows would mean
trouble), the dollar (a sharp decline to new lows would be negative) and crude
oil (another $4 bucks on the upside would start to drag on global growth).
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Note that the base metals
look to be breaking down from intermediate-term toppy patterns after sentiment
has been astronomic. While this is a secular move possibly in the making, these
should take a breather here for a while. The dollar is drifting, not crashing,
despite the terrorist buildup in action as Ramadan’s end gets closer.
Gold stocks, particularly juniors, are still soaring, but remain vulnerable
to a setback as they are becoming overdone vs. gold itself. Commodity currencies
continue to drift higher, but could also experience decent corrections if commodities
in general sell off a bit. We would take half profits in the CRB from the buy
signal we remarked on many weeks ago — and use a lock-in profit trailing
stop on the other half.
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Unlike other recoveries,
in this one we suggest investors get less bullish as the markets move higher,
not more bullish.
Our US long/short model
is doing reasonable well considering the low level of allocation it has had.
We have long encouraged investors to supplement this strategy with or favorite
foreign and global asset plays. Investors should continue to cautiously add
stock exposure as trade signals are generated that meet our strict criteria,
as well as allocate to our favorite segments. Our model portfolio followed in
TradingMarkets.com with specific entry/exit/ops levels from 1999 through May
of 2003 was up 41% in 1999, 82% in 2000, 16.5% in 2001, 7.58% in 2002, and we
stopped specific recommendations up around 5% in May 2003 (strict following
of our US only methodologies should have portfolios up over 11% ytd by our calculations)
— all on worst drawdown of under 7%.
Last week in our Top RS/EPS
New Highs list published on TradingMarkets.com, we had readings of 50, 38, 17,
22, and 19, accompanied by 8 breakouts of 4+ week ranges, no valid trades and
no close calls. Internal strength remains slightly suspicious. Position in valid
4 week trading range breakouts on stocks meeting our criteria or in close calls
that are in clearly leading industries, in a diversified fashion. Bottom RS/EPS
New Lows remained non-existent with readings of 5, 7, 6, 5, and 0 with two breakdowns
of a 4+ week ranges, no valid trades and one close call in
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remains bleak, but watch for signs that it is improving here closely.
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For those not familiar with
our long/short strategies, we suggest you review my book The Hedge Fund Edge,
my course “The Science of Trading,” my video seminar, where I discuss
many new techniques, and my latest educational product, the interactive training
module. Basically, we have rigorous criteria for potential long stocks that
we call “up-fuel,” as well as rigorous criteria for potential short
stocks that we call “down-fuel.” Each day we review the list of new
highs on our “Top RS and EPS New High List” published on TradingMarkets.com
for breakouts of four-week or longer flags, or of valid cup-and-handles of more
than four weeks. Buy trades are taken only on valid breakouts of stocks that
also meet our up-fuel criteria.
Shorts are similarly taken
only in stocks meeting our down-fuel criteria that have valid breakdowns of
four-plus-week flags or cup and handles on the downside. In the U.S. market,
continue to only buy or short stocks in leading or lagging industries according
to our group and sub-group new high and low lists. We continue to buy new long
signals and sell short new short signals until our portfolio is 100% long and
100% short (less aggressive investors stop at 50% long and 50% short). In early
March of 2000, we took half-profits on nearly all positions and lightened up
considerably as a sea change in the new-economy/old-economy theme appeared to
be upon us. We’ve been effectively defensive ever since.
On the long side, we would
take partial profits as well on existing positions and tighten up trailing stops
on recent close calls from past weeks,
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as in the few favorite global sectors that still look strong (see discussion
above).
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Do you take profits if you
believe you will see a 10% correction in the markets before the uptrend reasserts
itself? Normally we would hold a larger core group of good RS stocks through
such a correction. But in the current high-risk environment, we would rather
be more defensive and have to re-enter again once the smoke clears a bit. We
still believe that we’ll have to be very nimble to profit consistently
and know when to pull the plug in this market, and when to time the hiccups.
A mini-mania could develop if global economic statistics start to change investor
psychology — or a shock could tank this market so quickly it would make
you dizzy. We’re probably going to experience a 10%+ correction as the
market transitions from liquidity to growth as its fuel. Investors are advised
to remain extremely flexible.
Mark Boucher