Breakouts And Clear Direction Still Not Quite Here
The
market backed off a bit over the last part of the holiday, with the
Dow ending down 5% on the year, the S&P and Wilshire ending down 12% on the
year, and the Nasdaq ending down 21% on the year.
The days leading up to New Year’s did not bring about the five or six
breakouts of close calls or up-fuel stocks meeting our criteria per day that we
have been looking for to get an all-clear signal from the market.
The Dow, the
S&P, the Wilshire, the World Index, and a host of foreign markets continue
to fight with their 200-day moving averages, but have yet to decisively break
above these critical levels. Ideally, the
broader market breaks out of its consolidation range on volume that outpaces
what we have seen for many weeks. That would be the green light for adding longs
to our portfolio at a rate of more than two per week. Until then, we still
remain very selective and are watching for breakouts in fundamentally strong
stocks, with special attention to group relative strength. Our portfolio
continues to do comparatively well based on this conservative approach, and we
would rather preserve our capital and wait for the all-clear signal from the
market before diving in headfirst.
Economically
sensitive commodities still appear to be building bases, though they have all
backed off of their base-high levels. The
markets would be clearly discounting imminent recovery if nearby lumber futures
could move strongly above the 275 level, nearby copper could move strongly above
the 75 level, nearby cotton could move strongly above the 42.50 level, and
nearby bonds fall on good volume below the 98 level.
Conversely, the
recovery scenario would be in serious jeopardy if lumber fell below 215, copper
fell below 60, cotton fell below 30, and bonds rose above the 105 level,
although such a reversal in these markets currently appears unlikely.
We also suggest watching the commodity currencies in their apparent
base-building process. Watch the Aussie
dollar for a move above .55 or below .48, and the New Zealand Dollar for a move
above .46 or below .39 to confirm the recovery/recession scenario.
The breadth and
leadership numbers for the week are still positive, but not yet where we would
expect them to be at the beginning of a sustainable move. Top
RS/EPS New Highs vs. Bottom
RS/EPS New Lows for the latest week were 26/0, 25/0, 28/0 and 6/1. The week
saw 20 or greater new highs on the majority of the four trading days, but
leadership is still lacking without a strong showing of 100 or more new highs on
one day. Breadth and leadership for new lows is non-existent, which has been the
case really since just after the Sept. 21 lows. Look for longs to reach 20 or higher
CONSISTENTLY in a week and over 100
on at least one day before becoming very bullish.
Breakouts vs. breakdowns of
four-plus-week consolidations on our lists for the shortened week were thin again at
2/0, 4/0, 4/0 and 0/1. This
amounts to 10 breakouts to new highs from solid bases — still far from our
idea of a robust market. There was
one close call this week in
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PowerRating), but no new trades as the quality of breakouts
is still not strong. We need more breakouts by leading stocks in groups with
good relative strength in order to participate in the next leg of the market
without accepting too much risk.
Our overall
allocation remains DEFENSIVE with 76% in T-bills awaiting new opportunities. 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 ended the year up about 16.5%, with a heavy cash
position. While this is by far
our worst year to date, it was done on a maximum drawdown of less than 5% this
year, and is substantially better than the market, which on the whole, lost about
12% on the year after a maximum drawdown of 40% from high to low. It is not uncommon for a great year to be followed by a less than great
one. At least investors can see in
this year that our defense allows us to keep building slowly on our huge gains
of prior years, even in a very poor market environment.
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 an environment unclear
directionally, we also 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: Possis
Medical
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@15.3 — took profits on 17.90 trailing stop; Central European Distribution
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@64.3 (72.28) w/65 ops; and Urban Outfitters
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PowerRating) @21.9 (24.55) w/23 ops. 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, and only in leading groups
until we get breakouts in the S&P and Dow. If two or more of our breadth criteria for the overall market develop
(described in detail in previous
columns), we’ll drop the “two per week only”
advice on longs — but until that happens, we’ll sit tight and let the market
give us more decisively bullish signals than we have seen to date.
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.
For most investors, 2001 was
a year of defense or a year of realizing the need for defense. We are hopeful that some sort of recovery may develop in 2002, though we
doubt that the markets will return to the ebullient days of the late 1990s
again any time soon. Nonetheless, we
expect a better year in 2002 than the tough 2001, albeit with perhaps more
volatility and risk. We hope that
those investors who followed our strategies are satisfied that they were able to
make decent returns in a tough environment while most investors took hits.