8 Things You Should Watch For During The War

• March 20, 2003
• Mark Boucher

As we have been warning investors, the battle
in Iraq has begun. Most intelligence sources indicate that the initial battle
of  “Operation Iraqi Freedom” was a surgical strike probably aimed at trying to
kill Saddam in a last attempt at a non-war solution. The long pause following
this surgical strike was probably needed for battle damage assessment, and to
allow Washington to determine whether they got Saddam or not. New bombing raids
have begun.

There is also reported
artillery battle around Basra. Iraqi forces defending oil fields around Basra
are almost completely civilian troops and there are reports that they are
negotiating for full surrender.  There are also reports of fires being set to
certain oil fields around west and south Basra, although the extent of damage of
the fires is not known. US marines are trying to advance from Kuwait to
extinguish the fires, but they are being attacked and having to use artillery to
clear their path to the wells. 

Investors need to keep in mind
a few things to watch for in events of Operation Iraqi Freedom: 

1. The markets
   are likely hostage to war news and changes in the winds, so the great breadth
   on the upside of the last week could turn on a dime on surprisingly negative
   news; 

2. Watch for
   broad-scale fires and damage to oil fields that could disappoint the markets; 

3. Watch for the
   use of chemical, biological, or radioactive weapons that would be a negative
   shock to the markets; 

4. Watch for
   indication of civilian surrender or military surrender that could boost
   markets; 

5. Watch for the
   iron-triangle to prolong the conflict; 

6. Watch for
   missiles or terrorist attacks on the US, US installations abroad, on those
   nations assisting the US, and on Israel, which would be negative for markets; 
   

7. Watch for
   other nations to jump into the conflict which would be a negative shock; 
   

8. Watch for
   some other attempts to assassinate Saddam or to get Republican Guard troops to
   coup to possibly end the war quickly.

Investors also need to keep
perspective. The full significance of the State Department official announcement
that “the Iraq campaign has been officially dubbed: Operation Iraqi Freedom”
should not be lost on investors. The significance of this statement is not the
name, it is the wording of the conflict as a “campaign.”  The press is calling
this the “Iraq-War” but it is not a war, it is just ONE campaign (as was
Afghanistan) in the overall war on terror that began on 9/11 when the US was
attacked by terrorists. There will be many battles in this campaign, and
unfortunately, there will likely be many other campaigns in this war. 

Victory in Iraq starts the
process of undermining the foundations of al Qaeda and other radical Islam
terrorist cells, but Iraq is only one of many support centers for
terrorism. There are also huge terrorism problems in Pakistan, Iran, Saudi
Arabia, Syria, North Korea, Albania and elsewhere, where al Qaeda remains
substantial and not necessarily with the blessings of the government in
power. Therefore, regardless of how quickly the Iraqi Campaign ends, there will
likely only be a pause of a year or less, before the next target for campaign
must be initiated — and it could well be much faster than that if events move
quickly.

The markets will be reacting probably violently in many directions from news of
the battles in Iraq. I don’t think the markets realize how difficult it will be
to develop democracy and stability in Iraq even after a successful military
campaign. And I don’t believe the markets understand that this is not a war like
the early 1990s version — it is a campaign in an on-going global war on
terrorism that will take many years to complete (the Bush Administration
estimates 10 years MINIMUM). 

I would be surprised if PE
ratios won’t trend down as the markets come to realize the truth about the
duration of global military conflict. So treat rallies with breadth and
leadership and follow-through a bit more cautiously than normal in this
environment even if they develop, and keep in mind that the great bear market
that started in 1999 in global markets may be far from over despite temporary
reprieves. 

Was last’s week’s huge breadth
a catch-able bottom in the making? Quite possibly. We had a 9/1 downside breadth
day followed by a 9/1 up breadth day, two follow-through days to the upside, and
many of our models are flashing buy signals. Breakouts, follow-through and
leadership have not yet developed, but if they do, we could get a better
environment ahead — although I strongly suspect this will not happen until
resolution of the Iraqi campaign is near at hand.

For investors HEAVY cash
positions are advised during this conflict — watch the fireworks from afar in
T-bills — that’s our version of Operation Investor Freedom.

Investors should keep a mix of
cash in various currencies (Everbank.com) and sit on their hands mostly until
the new campaign and health of the global recovery both develop more clarity. 
Watch and wait for volume, breadth, leadership, and
follow-through to emerge  in one direction before allocating serious
capital to either the short or long side.  Caution is still advised strongly. 

Since
March 2000 the world index is down over 45%, the S&P over 48%, the IBD mutual
fund index is down over 62%, and the Nasdaq has crashed over 76%.  Meanwhile
since March 2000 the long/short strategy we summarize and follow-up each week in
this column has made more than 39% on a worst drawdown of under 6%.
While this performance is certainly
underperforming our long-term growth rate, and it is hardly thrilling to have
been so heavily in cash since March of 2000, we have managed to eke out gains
with very low risk in a very dangerous market environment where 9 out of 10
traders have been big losers. 

Our official model portfolio
overall allocation remains VERY DEFENSIVE.  We’re now 84% in T-bills awaiting
new opportunities, with two sole long positions. Our
model portfolio followed up weekly in this column was up 41% in 1999, up 82% in
2000, up 16.5% in 2001, and up 7.58% in 2002, an average annual gain of over 36%
— all on a worst drawdown of around 12%. We’re
now down 0.2% for the year 2003.   

To our daily

Top RS/EPS New Highs list the entire rally from the 7/24 and then October
lows never even registered on the radar screen having mustered up just ONE solid
week of consistent +20 or higher readings since 7/24.  Bottom RS/EPS New Lows
are plummeting and the downward bias here is over, though an upward bias is not
yet entrenched.  We had readings of 6, 8, 11, 42, and 28 new highs last week in
our Top RS/EPS New Highs list, accompanied by 12 breakouts of a 4+ week range,
several close calls, and one valid trade in
(
GRMN |
Quote |
Chart |
News |
PowerRating).  Bottom RS/EPS New Lows last
week showed readings of 59, 59, 60, 7, and 3, accompanied by just 11 breakdowns
of 4+ week patterns without any clear close call on the short side. The
bottom-line is that highly reliable low risk opportunities remain scarce in this
uncertain environment.

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, and

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 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:
Port Financial
(
PORT |
Quote |
Chart |
News |
PowerRating) @40.99 (48.73)- w/  a 44.5 ops to lock in profits; 
WebMD
(
HLTH |
Quote |
Chart |
News |
PowerRating) @9.44-out on an 8.5 ops; and
long new
Garmin
(
GRMN |
Quote |
Chart |
News |
PowerRating) @34.79 (34.28) w/ 30.9 ops.  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 leadership and follow-through improve. 

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:
NONE. Continue to watch our NL list daily and to short any stock meeting our
down-fuel criteria (see

interactive training module) 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 we get better breadth numbers
on the downside and better leadership.

Investors and traders should be
on survival strategy here. Hopefully the little hiccups in the first day of
battle will convince you that the markets can turn on a dime in either direction
depending upon factors which are impossible to predict in Iraq. Clearly this is
not the kind of reliable situation a true investor is looking for, in my
opinion. Stay heavily in cash and aware of the risks, and when there is a
clearer path toward resolution that is signaled by breadth, follow-through, and
leadership, then investment strategies will payoff big.

Mark Boucher