Can This Bounce Turn Into A Catchable Rally?
Following 7/24’s big reversal
day we now have some spotty indications that a catchable rally is possibly about
to develop. First we got a 9/1 up volume
vs. up + down volume day on 7/29, the first breadth thrust of any kind we’ve
had since the bear market in stocks began in 2000.
Unfortunately, it occurred on substandard volume, an extremely rare
occurrence. Then we had a couple of
O’Neil follow-through days, though each one has been on volume less than the
50-day average, and the first one beyond the typical time frame to expect an
initial follow-through day to develop. And
in between the two follow-through days we had a distribution day, though it was
also on volume less than the 50-day average.
From a seasonal basis and from
a market structure basis, we would expect a decline into late summer to fall to
find a bottom and undergo probably the best bear market rally we’ve had since
2000. The degree of oversold basis the
market reached in late July both on a breadth basis and on a sentiment basis has
led to substantial rallies in the past. Additionally,
concerted stimulus is LIKELY to develop over the next couple of months globally,
and we would expect at least a temporary rally to develop off of this type of
concerted action, which has been absent since the recovery began last year.
Is this the low we would expect
in late summer-fall? It COULD be is about
the best answer I can give so far. What
we really need to see is continued positive volume action, and most importantly,
clear group leadership to develop with a substantial broadening in the number of
growth stocks breaking out of sound bases and continuing up.
And so far this is NOT what we’ve been getting.
If leadership and broader breakout participation can develop, then this
rally may develop into something nicer than investors have seen for nearly two
years. Let’s watch and wait to see if
this final confirmation can develop.
Continue to watch for another
breadth thrust (the first one was questionable because volume was light and
another of these would be a BIG plus for the broad market) like a 9:1 up/down
volume day, the 5-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. In this type of market, we have to
be very mindful that the market can do anything anytime — so watch and let it
signal to you with its own action what it is likely to do in the period ahead.
However, our best guess continues to be that sometime this fall (perhaps
already) we will get an intermediate-term bottom that will lead to a catchable
rally, maybe even the best quality rally we’ve had since March 2000.
But sometime in the first half of next year, this rally is likely to face
headwinds and turn back down for at least a retest of the lows of this
summer/fall. Wait for more leadership in
terms of groups breaking out of sound bases before trying to play this rally or
any other that starts this fall.
Another indication of strength
that investors are advised to watch is whether this market can rally on negative
news. A rising market despite coming
potential negative news on the earnings or economic front would be a strong
indication that this rally has real teeth.Â
Right now global markets are
discounting more rate cuts ahead. Concerted
global monetary stimulus would be a real plus for the market rally to gain
ground, at least in the intermediate-term, which is a tradable enough time
period. Realize, though, that
economically there is a big long-term question of whether these new rate cuts
will be any more long-lasting in stimulating the economy toward self-sustaining
economic growth than the prior rate cuts
have been. Deflation has engulfed Japan
for nearly a decade. With the bubble in
US stocks and developed markets, Switzerland has joined the deflationary world.
Are the US and Europe far behind? If
deflation develops, monetary policy will be less and less effective.Â
Another long-term concern is
the never-ending War on Terrorism. Bush
has instigated unreported raids on Iraq
that appear to strategically be preparing for invasion.
He has also recently gained backhanded permission to use the Saudi
airbases for launch of an attack. Yet
Iraq has solidified support from Syria such that any attack on either nation
would allow a commingling of forces, borders, and use of military forces and
posts. And Saddam has recent large arms
purchases from Iran that make it seem as though Iran might join its side in the
advent of war. Investors are advised to monitor debka.com for up-to-date
backstage war news.
The combination of major
monthly top patterns in many major global averages, deflationary forces gaining
steam, monetary policy losing effectiveness, and a possible war in the Middle East
that could bring huge forces against one another is enough to give one
nightmares. A conspiracy theorist might
surmise that if the global recession re-emerges and policy stimulus fails to
curtail deflationary forces, WWIII is already being set up to respond to global
depression.
Let’s not expect such an
unlikely series of events, but also realize that such a nightmare scenario is no
longer impossible. We haven’t attacked
Iraq, no one has joined their side, the world is not yet in a deflationary
slump, and the US economy in particular is substantially more able to adjust to
changing economic environments because it still has free-market roots.
Plus, we have a great dictator of monetary policy, Greenspan, at the helm
of what I would argue is a bad system. But
he still has lots of tricks up his sleeve. And
global monetary authorities are starting to all get the picture that fighting
deflation is the top priority. So
nightmare scenarios still seem very unlikely to develop.
And I believe our strategy can
continue to do reasonably well over any potential scenario one can envision (at
least where markets are still open).Â
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 since then 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 nine out
of 10 traders have been big losers. Sometimes
just playing good defense is the most important aspect of winning the game.
Remember low-risk investing is streaky — there are periods of
substantial gains (41% in 1999 and then 82% in 2000), and there are periods of
less impressive ones. But if your average
returns are over 20% and you can keep risk and volatility to a minimum, you’re
accomplishing your goals and doubling your money every 3.5 years (taxes not
considered). And that’s worth getting
excited about! So yes, this may not be the most fun period investors have ever
faced, but maintain your discipline and your defense, and the next time we get
the ball by getting a better investing environment, we’ll be able to go after
opportunities with confidence to produce steep gains again and again.
We may even be approaching a better environment quite soon.
Top
RS/EPS New Highs did strengthen some this
week, but still remain weakly below 20 a day consistently with readings of 9,
16, 14, 13 and 18. It is surprising to
see fewer than 20 consistently given the breadth-thrust and good volume of this
rally to date. Wait for solid leadership
in the breakouts before thinking about getting aggressive on the long side.
Bottom
RS/EPS New Lows did decline sharply this week, yet they stayed stubbornly
above 20 (again surprising) with readings of 45, 29, 25, 56 and 62.
We had just 12 breakouts of four-plus-week consolidations on the upside
with a close call or two (like OSTE), and only three breakdowns of four-plus-week
consolidations without even a close call. Breadth
of breakouts has collapsed on the downside, and expanded some on the upside, but
is still not at decent rally levels yet. Remain
heavily on the sidelines until the environment improves and opportunity
breakouts of close calls become more abundant.Â
Our official model portfolio
overall allocation remains ULTRA DEFENSIVE. We’re
now 100% in T-bills (including short sale proceeds) awaiting new opportunities,
and 8% invested in one lone short position. 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 5.58%
for the year 2002. Let’s wait for a
bit better environment before positioning heavily.
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 NH’s 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 Arrow
Electronics
(
ARW |
Quote |
Chart |
News |
PowerRating) @17.97 (16.69) w/an 18.2 ops. 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 market volatility is more
normalized.
The major critical question is
whether this new bear market leg means renewed global recession and a very
negative scenario, or whether it merely pushes global monetary authorities to
save slowing growth from becoming negative via more concerted monetary policy
stimulus. We suspect they will
engineer another saving attempt at least because Greenspan knows the danger and
the cost.
Will he save us from a brutal
global recession now and further global deflationary disaster?
Continue to watch global bonds, global stocks and global commodities
closely, as this may be the most important period in your economic lifetime
directly ahead. We
will continue to try and navigate these treacherous markets aiming for decent
gains with relatively low risk and safety.