What Is Needed On Rally Off Sept. Lows
Both the dollar and the market have gotten to levels
of sentiment and oversold conditions that a relief move
against the trend should develop for days to weeks at least. Both markets appear
to be rallying off of support levels. Now let’s see if we can get some
follow-through days and breadth expansion on the upside to at least turn this
potential rally into something catchable. Economic reports should be more
positive and give the market reason to look better, while reports from Europe
should be worse than expected, giving the dollar a brief boost.
However, traders and
investors should realize that breakdowns to lows below the September lows in
most of the major indexes, along with new lows in the dollar, will be a scary
prospect and the potential for a deflationary outcome and severe further
downside in the market would become much more likely, if that develops. The
critical region is the 925-950 support level in the cash
S&P
(
$SPX |
Quote |
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PowerRating). If this level gives way, then the economic
environment will clearly change for the worse.
Notice that the
commodity markets have been signaling that the recovery will not be
aborted. This week, the CRB broke out to new recovery highs. Follow-through up
by the CRB and confirmation by the Goldman Sachs commodity index would be an
all-out signal that the recovery was continuing. Investors could play this with
the mutual fund QRAAX, as well as base metal and basic materials stocks, should
it develop. If the rally develops some breadth and follow-through in the US,
then the EMs should reclaim their position as leaders as well. So let’s watch
carefully the market action from here, and move as it tips its hat.
Also remember that
our own breadth tools have not flashed buy signals since the early 2000 top. We
will therefore be keeping our eye out for a 9:1 up/down volume day, the 5-day
moving average of advancing volume to be 77% or more of total volume, an 11-day
A/D ratio of 1.9 or more, or a 10-day A/D ratio of 2 or more to make for a
totally confirmed bull move. However, we would not be surprised to see a couple
follow-through days and no further breadth confirmation, leading to a small but
barely catchable upmove similar to what we had off of the September lows.
From a psychological
and economic standpoint, the US and developed markets need more evidence of
broad-based earnings gains so that earnings gains can begin to take over from
monetary stimulus as the fuel behind stock price gains. Our macro analysis along
with study of the market’s reaction to overvaluation historically tells us that
although the market can ALWAYS DO ANYTHING, we are
probably wise to expect only a potential MINI bull
move — playable, ala 1965-1982, but nothing like the bull moves of the
1982-2000 secular bull markets, for many years to come.
Our US long/short
strategy continues to show reasonable gains with very low risk this year. We’re
making money at a 1%-20% annual rate so far this year, OK, but not exactly
wonderful. Investors may have to adjust to a lengthy period of global multiple
convergence, where overvalued US stocks have trouble rallying en masse
for many years, while certain sectors present limited but good opportunities
such as we’ve seen in the homebuilding and regional banking industries this
year.
Top RS/EPS New Highs this past week
weakened with readings of 35, 56, 33, 9, and 6. We did have several close calls
on the upside but no long trades on new high breakouts, despite the decline in
breadth. Once again now we clearly need more quality leadership for any rally to
take hold, along with broader participation before getting more aggressive on
the long side. Wait now for at least a couple follow-through days before
anticipating that this retest is over. Bottom
RS/EPS New Lows were erratic and less strong this week than last week with
readings of 43, 17, 33, 87, and 107. The quality of new lows remained
marginally OK with several close calls but no new trades. There were 20
breakouts of four-plus week trading ranges on the upside and only 12 breakdowns,
showing the poor quality on the downside at this critical retest
area. Nonetheless, continued improvement in new low numbers and quality will
help tell us whether this is a retest of the September lows or whether it is the
beginning of a new leg down in an on-going bear market. Watch carefully!
Our official model portfolio overall allocation remains
QUITE DEFENSIVE. We’re now 108% in T-bills (including short sale
proceeds) awaiting new opportunities, and 40% invested in three short and two
long (our short proceeds finance our long trades) trades.
Our model portfolio followed up weekly in this column was
up 41% in 1999, up 82% in 2000 and up 16.5% in 2001 — all on a worst drawdown of
around 12%. We’re now
up around 9.1% for the year 2002.
For those not
familiar with our long/short strategies, we suggest you review my
10-week trading course on TradingMarkets.com, as well as in my book
The Hedge Fund Edge, course “The Science of Trading,” and
new video seminar most of all, where I discuss many new techniques.
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 US 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
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.
Upside breakouts
meeting up-fuel criteria (and still open positions) so far this year are: long
NCEN @31.95 (30.06 ) w/ 26 ops; and long QCBC @32 (split)
(34.14) —now use a 32 ops to lock in a break even trade. Continue to watch our
NH list and buy flags or cup-and-handle breakouts in NH’s meeting our up-fuel
criteria — but be sure to only add names that are in leading groups, and now
only add two trades per week once again until the market environment improves.
On the short side
this year, we’ve had breakdowns from flags (one can use a down cup-and-handle
here as well) in stocks meeting our down-fuel criteria (and still open
positions) in ILXO @13.76 (11.24) w/ 15.5 ops;
CWP @7.77 (7.7)
—now use an 8.1 ops; and short CMNT @6.63 (6) —now use a 6.6 ops.
Continue to watch our NL list daily and to short any stock meeting our down-fuel
criteria (see
10-week trading course) breaking down
out of a downward flag or down cup-and-handle that is in a leading group to the
downside but only add up to two in any week (and only in the weakest groups)
until market weakness is more pronounced.
Will the US
bubble-popping bear market pull the world back into a deflationary slump? The
market’s actions over the next few weeks will be key. If the market can muster
up some follow-through days on the upside and breadth can continue to expand,
then the global manufacturing recovery will survive for now and a better
investment environment for EMs and some growth stock plays will develop. If the
broad markets all make new lows on strong volume and weakness continues, it will
be a much broader bear market than we’ve seen in decades. Watch the plurality of
markets for clues as what the next move will be.