Bear Bumps Along
No sooner
does the market show us clearly that we are in a bear market than it
undergoes a sharp rally. That’s exactly what bear markets are like — they’re
trappy, fickle, treacherous animals. And that’s why investors must continue to
remain very defensive until a new bull market proves itself with a high degree
of clarity.
On the economic front, May Copper has
plunged to new lows, and lumber has reversed its head-and-shoulders-bottom
breakout and fallen deeply back into the base. Only bonds seem to be signaling
the potential for an end to weakening economic conditions so far. Investors
should be cautious and assume that the economic weakness will continue until
nearby Copper closes strongly above 85, nearby Lumber closes strongly above 250,
AND nearby long bonds close weakly below 102. Only when the economic signals
become clear should we get excited about a potential market reversal, I would
suspect. But the real key to the stock market will be to watch breadth. When our
Top RS/EPS New High list numbers consistently and substantially number more than
20 every day, and when we get a handful or more of stocks that are breaking out
of sound bases that have fuel or very nearly have fuel in a given week, that’s
when we need to sit up and take notice. Until then, fellow traders, continue to
tread cautiously and batten down the hatches. This bear could be nearly dead, or
he could be with us for another year. We’ll just have to let the market
show us and wait patiently.
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Let’s
look at some numbers from the week. New
Highs versus New Lows
on our RS/EPS lists were 5/139, 3/23, 7/10, 16/15 and 11/32 — which tells
us that there is, once again, no clear dominance by longs or shorts without a
consistent reading over 20 all week by either side. There were 15 breakouts on the upside
to new highs of stocks on our Top RS/EPS New Highs lists, with 26 breakdowns on the
downside of four-week-plus consolidations on our Bottom RS/EPS New Lows lists. We had
a quick stop-out of one of our shorts from last week and a few close calls on
new signals on the short side, but no new trades for the week. Investors should
now continue to monitor closely for potential short sales in the sub-groups and
groups that appear most frequently on our daily lists of Bottom RS/EPS New Lows
group and sub-group summaries. We’re not in an aggressive bear market mode yet,
so wait for real opportunities that meet all of our short-sale fuel and breakout
criteria (you might want to review our “Art of Short-Selling” lesson
of a month or two ago). And continue to be very cautious, with a bias toward
avoiding trading unless everything is just right. This is the type of
environment that can chew up your capital, even on the short side. Investors
wanting more trading activity should try to tame their desires — but this past
couple of weeks, it looks like a large number of banking stocks have broken
down out of large topping formations, and traders looking for trades could look
here. We’ll remain on the sidelines until stocks meeting all of our criteria
appear en masse.
Our
overall allocation is still VERY DEFENSIVE, with 92% in T-bills awaiting new
opportunities, and 8% in short-sales. Our model portfolio followed up weekly in this column ended 2000 with
about an 82% gain on a 12% maximum drawdown, following a gain of around 41%
the prior year. For year 2001, we
are now down about 3%, with a mostly cash position.
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 and course “The
Science of Trading.” 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.
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, and are now as
defensive as possible.
Upside
breakouts meeting up-fuel criteria (and still open positions) so far this year
are: none; and last week we had no valid
pattern breakouts up in stocks meeting our up-fuel criteria (see 10-week trading
course). Continue to watch our NH list
and buy flags or cup-and-handle breakouts in NH’s meeting our up-fuel criteria —
but continue to add just two per week.
On
the downside, 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: Rogers Communications
(
RG |
Quote |
Chart |
News |
PowerRating)
@ 14.32 (14.70) w/16 ops; and Cubist Pharmaceuticals
(
CBST |
Quote |
Chart |
News |
PowerRating) @ 15.31 (15.31)
out on 24.25 ops (we tried to tighten up a pattern with a very wide stop some,
and it cost us a whipsaw here). 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. Here, too, remain
cautious by only adding two shorts in a week, until we get more consistency
in the number of downside breakouts in a given week off of our Bottom RS/EPS New
Lows lists.
Our
strategy remains simple and relatively cautious as well: protect against
whipsaws by waiting patiently for really low-risk highly
reliable trades that meet ALL of our criteria. Remember our goal
is to make consistently better-than-market returns (20%+
average annually) with relatively less drawdown risk than the market. Smile and think of the carnage we’ve just avoided from
the sidelines. When valid breakouts
of up-fuel or down-fuel stocks become abundant again, we’ll pounce with both
hands. Until then, we must tread
cautiously to avoid getting chewed up.