A Playable Rally Is Underway — Here’s Why

• October 1, 2004
• Mark Boucher

Breadth
Expanding in Cautious Global Equity Rally

We’ve been talking about a
rally to test and possibly break above last year’s highs occurring as the
markets anticipate a stabilization of the deceleration in the global economy
that has developed over the last many months.   The rally is gaining breadth
slowly over time.  This week Materials, one of the sectors we’ve been
highlighting has broken out to a new high.  EM’s continue to lead as
well, particularly Latin America which is resource dominated, as our strong RS
Australia, South Africa, Russia, and Canada.  Belgium continues to lead and
remains one of our favorite RS countries, and is joined by Sweden leading in
Europe.  Singapore is leading in Asia.  Steel and chemicals are shining.
Commodities are rallying with oils and metals.  Mid-cap and small cap value are
breaking out to new highs both in real terms and relative to the S&P. Even the
laggard techs and semis are starting to participate — the QQQ’s broke out
above their 50 and 200 day ma’s on good volume and MSFT broke out of a
multi-month trading range today — with wireless being the leading segment of
this group, also at a new high. 

Investors can and should play a
diversified group of these leading groups both outright and versus US and global
indexes — but with more caution than would normally be the case for what
broad-based signals.  The FBI is on full alert until the elections in the US. 
There are over 10 global elections in the next month and a half, and this is
prime-time for terrorists to attempt something that could lead to an overnight
shock of unknown proportions.  Avoid too much net long exposure and mix relative
plays versus spiders and global ETF’s with outrights to cut this potential
risk.  Yet investors should realize that IF we can get through the next month
and a half without a major terrorist act and breadth continues strong — the
likely final bull leg of the bull market that began in Oct 2002 will likely be
on roll into the first or second quarter of 2005.

Commodities have heated up
again and not just in the oil patch.  Base metals and metals in general have
picked up and contributed to a retest of old highs in the CRB.  The dollar is
starting to weaken versus most currencies and the Euro is on the verge of a
material breakout that could set up a retest of its highs later this year. 
Let’s see if the communiqué from the G-7 meeting this weekend has a surprise
reference to the dollar needing to adjust to current and chronic current account
flows.   The markets reaction to such a statement will set the tone for the
fourth quarter in forex.

Global and US bonds look close
to a peak level.  The Fed is still talking tough, but it is likely that the pace
of interest rate hikes will slow soon, as consumer confidence, leading economic
indicators, job growth, and industrial production are all slowing down in the
US. 

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
had portfolios up 17% for the year 2003) — all on worst drawdown of under 7%. 
 This did not include our foreign stock recommendations that had spectacular
performance in 2003. 

This week in our Top RS/EPS New Highs list published on TradingMarkets.com, we
had readings of 43, 73, 65, 100, and 89 with 34 breakouts of 4+ week ranges, no
valid trades and close calls in GGC and JUPM.  Breadth is
expanding again and more close calls would be a call to add some long exposure. 
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.  This week, our bottom RS/EPS New Lows recorded readings of 12, 10, 22,
18, and 6 with 11 breakdowns of 4+ week ranges, no valid trades and no close
calls.  We’re still not getting a lot of trading signals in valid breakouts,
though the environment is improving slightly on the long side — let’s see if
this holds up now that some resistance levels are close at hand.

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 of change in the
new-economy/old-economy theme appeared to be upon us. We’ve been effectively
defensive ever since, and did not get to a fully allocated long exposure even
during the 2003 rally.

We continue to believe that a playable rally is underway, but that it entails
significant shock-risk.  We’re in high risk but high potential reward mode in
global equity markets.  It’s not the early 90’s with good value, dropping rates,
strong plurality of markets participating and a nirvana equity environment.  And
it’s probably not even 2003, with high values but positive liquidity and
breadth.  Yet the rally is catchable for traders, who know how to mix outright
longs with relative value plays that feature the strongest sectors over the
market as a whole or weaker sectors.  Investors should participate but with less
allocation than normal, and be fully aware of the risks.  The good news is the
trading range environment is ending. 

Mark Boucher