Bear Rally Over
The
action this week made it clear that the bear market is not yet
finished. The S&P and Nasdaq closed
at new closing lows and broke to new bear market low territory.
The S&P has now confirmed a bear market by declining 20% from high to
low for the first time since the early 1990s. The
Wilshire, one of the broadest U.S. market indices, has declined 23.5% from high
to low since this bear market started. The
Russell 2000 has declined 28%. The Nasdaq
and QQQs are off over 58% from highs to bear market lows.Â
Bear
markets can be frustrating animals. Short
opportunities appear, but often months of profits on the short side can be
erased in just a day or two of massive short-covering rally.
Bear market rallies fool the majority and bargain-hunters jump into the
long side again and again and again. Most
funds are down this year and most traders are experiencing whipsaws in this
up-and-then-down market environment. Our
strategy is keeping us consistently on the sidelines, and frankly, this looks
like the right place to be.
This
week gave way to new lows in both Lumber and Copper, the two best economic
leading indicators in the markets. The
economy is not yet showing signs of recovery with new lows in these two markets.
Once they have broken out of solid basing patterns, then expect the
economy to begin giving more promising signs in the months ahead.
Nortel
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PowerRating) was a disaster and the techs continue to get pounded.
Remember that the Naz PE could drop to 20-40 to get to normal levels, and
that means substantial downside left potentially to return to historically sane
levels. Investors should give the bear
room and let him play with other people’s money until it is very clear that he
has gone into hibernation. We may get
some long and short opportunities with small allocation in the months ahead, but
it will likely take some evidence of economic recovery before the broad market
environment turns positive enough to warrant risking our hard-won gains in
force. Remember that when others are getting killed, waiting quietly and
patiently means your buying power only expands compared to everyone else.
Smile! We just missed getting
chewed up in another bear market rally folks!!!
IF
we can get a solid recovery off of lows made today or tomorrow, this may lead to
a brief rally again. Let the rallies
prove themselves clearly before even dipping your toe in the water.
We had had our finger on the trigger over the last few weeks, awaiting
more valid breakouts of up-fuel stocks. Go
ahead and take your finger off the trigger now. Instead
have a “show-me” attitude now.
Let’s
look at some numbers from the week. New
Highs vs. New
Lows on our RS/EPS lists were
23/6, 14/10, 29/24 and 11/39.
There is no dominance here in either side.
Yes, it’s a bear market, but it’s more of a downward-trending trading
range than a real bloodbath. And so no
strong breadth is developing on either side enough to warrant strong exposure.
There were roughly 11 breakouts on the upside (a good environment will
show six times this number or more) with 24 breakdowns on the downside of four-week-plus
consolidations on our RS/EPS lists. New
low breakdowns really gained momentum this weak, and breakdowns and potential
shorts are mildly in the driver’s seat again. However,
most importantly, there were no valid breakouts on the upside in up-fuel stocks
and no valid breakdowns on the downside in down-fuel stocks.
This week showed a decrease in the number of breakouts that were CLOSE to
meeting our up-fuel criteria and close to meeting our down-fuel criteria.
Remember that many close calls in either direction is a plus and is the
first indication that a better trading environment is returning.
This past week we had valid breakouts in stocks very close to meeting all
of our up-fuel criteria in Daktronics
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PowerRating) (not a leading group).
On the downside, we had close
calls in Avici Systems
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PowerRating) and Iasiaworks
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PowerRating) (both didn’t show
enough increase in volume on the breakdown). Impatient
traders can take some of these close calls if they feel they must trade — but
do so with half or less of normal allocation. We
suspect that over time those who continue to wait patiently for highly reliable
trades to show up will be ahead of those who jump on less-reliable opportunities
out of boredom. We’re just not quite
there yet on either the long or the short side, so let’s let the impatient
traders get whipsawed while we wait for real opportunities.
Our
overall allocation is now 100% in T-bills awaiting new opportunities for the
first time since 1998. 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 1.3%, with a full cash position.   Â
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.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: no open positions at
the moment; and this last week we had no
valid pattern breakdowns in stocks meeting our down-fuel criteria (see 10-week
trading course). 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.At
this point our strategy is simple: protect against whipsaws by waiting patiently
for real low-risk highly reliable trades that meet ALL of our criteria, or until
it is clear that the environment is very biased directionally.
One key missing ingredient of such an environment is solid and clear
group leadership — so far it is absent, and until it returns, we must remain
cautious. Our goal remains to make
consistently better-than-market returns with relatively little risk.
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.Â