Breakdown, But Internals Still Not Negative

April 26, 2002
Mark Boucher

While
the major indexes, and particularly the overvalued Nasdaq, are doing
quite poorly this year, the leading segments of the global recovery remain
pretty strong so far. Emerging Markets in
Asia made new highs this last week, as did Emerging Markets in Eastern Europe.
Small-cap value sectors continue to be quite strong.
And our slightly long model portfolio has so far continued to rise in
this environment.

However, a collapse by the Naz
will likely begin to take all carts down some â€” with the EMâ€™s being perhaps
exceptions. The fact that the S&P,
bonds and the Dow all broke critical Fib levels of last week is not a positive
sign for the short-term action of the market as a whole.
Therefore, we are cutting our positive rating on the market to neutral.
For now only add two longs a week until the environment improves once
again.

Normally at this stage of
global recovery there is a transition from a monetary liquidity-driven rally in
stocks to a profit-driven phase. Thatâ€™s
definitely happening in EM Asia and EM Eastern Europe.
But this transition has been much slower than normal in both the U.S. and
developed Europe. The profitability of
this recovery for most U.S. companies has so far been anemic.
Fortunately when we limit our purchases to leading groups, there are some
dynamic moves, as we had in several new trades this week.

But unfortunately, with the
breadth of Top RS New Highs being below a real bull run, the number of such
opportunities is relatively low â€” and this has kept us in a fairly low
allocation. Weâ€™re making money at a 20%
rate so far this year, OK, but not exactly wonderful.
Yet in this environment such gains are rare.
And while our strategy profit is decent, it isnâ€™t as large as those
investors who have taken our suggestion and ventured into the Emerging Markets
â€” where we suspect most of this yearâ€™s gains will be made.

Until the leaders (EMs and
small-cap value) begin to show clear weakness, the global recovery scenario is
intact. Last week we suggested that
investors should not be surprised to see overvalued high-tech and communications
stocks fall to new lows while the leadership continues to march ahead.
So far that scenario is unfolding. Global
and Fed rapid rate cutting prevented a deep recession, but it also preserved
overvaluation, and this overvaluation must now be worked off over time.Â

Investors are advised to
continue to closely monitor the commodity markets.
Economically sensitive commodity indexes and markets are on the whole
still positive the recovery scenario. Lumberâ€™s
response to import tariffs is a one-time reaction that should be overlooked.
Economically sensitive currencies continue making new highs as the NZD
and AUD have approached critical resistance
levels. A clear breakout above current
levels in both the AUD and NZD will confirm the global recovery scenario.

On the other hand, weakness now
in copper, cotton,
lumber, and commodity currencies, accompanied by further strength in global
bonds, would signal a softening in growth and a change in scenario.
Let the plurality of markets be your guide.

We have been warning investors
to expect difficult-to-trade ranges and lackluster activity in the broader
market averages. Hunt for undervaluation and avoid overvaluation.
Keep looking for an improvement in breadth, such as:

a 9:1 up/down volume day
(exceeded 6:1 this week but not quite there yet)

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

We want to see this improvement
before getting aggressively bullish the market. A
true secular bull market will give these kinds of breadth indications â€” though
this move may not. Weâ€™ve had a relative
scarcity of strong growth stocks at good value breaking out that meet our
criteria so far in this move and that has kept our allocation small.yes”> Continue to keep your powder dry until true opportunities meeting
all of our criteria appear.

Top
RS/EPS New Highs exceeded 30 every day
this week, but barely. There were only
six breakouts this week, although one in Group 1
Automotive
(
GPI |
Quote |
Chart |
News |
PowerRating) gave us a new trade.
Nonetheless, the action is no longer clearly bullish here.
Bottom
RS/EPS New Lows expanded all week and we had some close calls along with the
same number of four-week plus consolidation breakouts as in our Top RS/EPS New
High list. But a real major decline
should show expanding new lows fast â€” this so far acts more like a retest in
the broad market than a new wave down, although the Nasdaq overvalued segment
may continue to weaken continually.Â

Our overall allocation remains
DEFENSIVE, with around 70% 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 â€” all on a worst drawdown of around 12%. Weâ€™re now
up over 8.1% for the year 2002, mainly driven by a select couple of names which
is often the case in a market that is searching for leadership. Due to the
volatile nature of the U.S. market, we will probably see more frequent and
larger drawdowns than weâ€™ve had so far.

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.

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.

Overall, a plurality of markets
is still confirming the global recovery scenario, and the big picture will
remain healthy as long as Emerging Markets, commodities, and small-cap value
show leadership.

Breakdown, But Internals Still Not Negative

BUY THE FEAR, SELL THE GREED

Quick Links

Company Info

Contact

Company Resources