Breadth And Leadership Still Needed
As I mentioned previously, sentiment indexes on a broad
basis got to extremes not seen in many years off of the 10/10 lows. However,
short-term sentiment gauges have now bounced the fastest of any rally since
March 2000, and are now getting to levels that have preceded tops in this market
since the 2000 peak.
In addition, the S&P and Dow are both close to Fibonacci resistence levels and if they gap up Thursday and then decline off of these
levels, it will be more confirmation that a short-term reaction at least could
develop. All of which is possibly useful information for a short-term trader,
but not much use via our strategy.
It appears likely now that Bush will wait for some UN
attempts at action against Iraq before proceeding with war. That gives the
market some breathing room for many weeks. Oil prices are dropping off some,
relieving some deflationary pressure. If the Fed cuts rates after the FOMC
meeting in early November, then we may get a catchable rally out of this sharp
move in the averages. However, breadth and leadership are still clearly lacking,
at this point.
MME and some HMOs have been trying to show leadership. But
nothing approaching the solid leadership we would need and expect during a
really decent and play-able rally. Not yet at least. Breadth has also been
very poor so far. We have had one follow-through day on the 14th but
in general, volume has been declining on average during this rally. We have had
no 9/1 up/down volume days or other breadth thrusts such as the five-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. Finally and most
importantly, breadth on our Top RS/EPS new highs lists have been pathetic and
have not registered any kind of consistency above 20 for a full week. Numbers
are low and not yet indicative of the type of breadth needed to fuel a sizeable
number of growth stocks higher consistently.
Breadth and leadership will tell
the tale of whether we have reached the hoped-for low, from which a decent rally
can develop, or whether this will be another fake-out prior to new lows. Watch
and wait patiently until you see consistent breadth, solid leadership, and
dozens of breakouts of 4+ week consolidations in stocks at least close to our
criteria, before committing serious capital to the buy-side. The short-side
currently looks equally dismal. Fed easing would help and could be a catalyst
leading to the type of breadth and leadership this market needs.
Investors are advised to not worry about the market
“getting away from us,†and just watch carefully to determine if we are getting
the breadth, the leadership, the breakouts, and the setups we need to start
moving more aggressively toward the buy side.
There are some positive indications that lead us to suspect
that we might get better action soon. Bonds
(see above) are getting trashed, unlike the
July to August rally. Remember that this is what we want to confirm stocks move
in a deflationary environment. The action in some commodity currencies (AD) and
in some economically sensitive commodities is BEGINNING to look potentially
positive (copper, lumber, cotton).
(See charts below.)
Foreign stock markets
ARE participating in
this rally. Asia, which didn’t do much during the July rally, but is usually a
leader in the event of global economic recovery, is at least participating in
this rally, though not yet leading it on the upside. Corporate yield spreads
are hesitantly inching lower, still not providing much confirmation that markets
are discounting an improvement in economic growth soon, though. EM debt, though,
is rallying nicely, and may prove to be a better way to play recovery if US
corporate yields remain sticky. Let’s watch for more confirming action via
positive moves in commodity currencies, in economically sensitive commodities,
in foreign market confirmation, and in yield action before getting too
bullish.
Don’t take your eye off of oil prices either. A
substantial rise in oil prices could kill this market, while a substantial
decline in response to positive Middle East developments, could propel the
market substantially higher.
Until we get solid indications of real leadership and
breadth, despite sharp rallies from oversold conditions, this remains a very
treacherous market environment. There is now good reason for hope that a
change is developing — but until that change is clear, caution should continue
to be paramount. Many shorts got killed on this rally off of 10/10, while
anyone long nearly anything since late August has felt pain and volatility as
well. Avoiding this carnage is a key to successfully producing substantial
gains with acceptable risk, which is the goal of any investment plan.
We remain watchful and hopeful that this rally materializes
into something that can provide decent long-side opportunities, but until we get
more evidence of leadership and breadth, our strategy remains ultra defensive,
but continues to slug out small gains.
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 38% 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. We will hope and
watch for a better environment, but wait patiently until it arrives before
risking significant capital.
Our official model portfolio overall allocation remains
EXTREMELY DEFENSIVE. We’re now 100% in T-bills awaiting new opportunities.
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 6.17% for the year 2002. Let’s wait for a bit better
environment before positioning heavily.
What are we talking about in terms of better breadth?
Top RS/EPS New Highs have still never mustered up one single solid week of
consistent +20 or higher readings since the 7/24 lows, let alone since 10/10
lows. Readings this week were improved, but hardly indicative of broad-based
participation at 24, 9, 30, 18, and 16, accompanied by just 13 breakouts of 4+
week consolidations within these new highs, with just one or questionable close
calls. Let’s see if we can get 20+ breakouts consistently over the next week
accompanied by even more breakouts that show consistent group leadership.
Bottom RS/EPS New Lows have clearly plummeted, helping to confirm the rally
with readings of 17, 15, 15, 15, and 20, accompanied by just 3 breakdowns of 4+
week consolidations, the lowest number in some time, with no close calls.
Notice that our analysis of new low breakout quality helped keep us from getting
trapped on the overly bearish side of the market in the decline from late
August.
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 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 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: NONE. Continue to watch our NH list and buy
flags or cup-and-handle breakouts in NHs 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: NONE. 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 we get better breadth numbers on the downside and better leadership.
Is this another false start or the beginning of some
trading opportunities? There ARE some indications that this rally has the
potential to materialize into something, particularly if we get a rate cut. War
concerns early next year could be a problem down the road, but until then, a
window of opportunity could develop. But we need now wait, watch, and let our
indicators that have guided us so well thus far, be our guide.Â
We want to catch
a reliable and durable move and yet avoid anything that isn’t reliable or
durable. There are still HUGE potential risks in this market and both bulls and
bears are getting chewed up in this environment. But now is a good time to
begin watching our new high lists carefully for indications of potential
breakouts of stocks meeting our criteria, and for evidence that leadership and
broader participation is developing.
Until next week,
Mark