Consider These Possible Hedges

Iraq has until Saturday to begin dismantling missiles found in clear
violation of UN resolutions and Blix has his “bad cop” hat on this week.
The US has enlisted Spain and Mexico in its cause and is pushing others
who are starting to lean in its direction. One
Russian senior official stated he believed Russia would not veto the latest
resolution backed by the US, UK, and Spain making the threat of force clearer.
Has the war already unofficially started?

Investors need to realize that this is a different type of conflict than
any before. It is not missiles and
traditional military we are concerned with — it is the combination of an oil-rich
country bent on arming itself, with major ties to terrorist organizations whom
it arms, trains, and recruits to attack the US with suicide missions.
We’re not afraid of ICBMs this time — but men carrying biological,
chemical, or radioactive devices. And
we’re also afraid that Iraq could do all this without much opposition, under
the umbrella of a nuclear weapon it could blackmail the world with.

Look how timid our policy is toward North Korea which intelligence is confident
already has a nuclear bomb to use. Warmongers
are right in noting that we need much more serious containment of Iraq than the
UN can possibly supply with forces not designed for fighting or to be a serious
threat. On the other hand, attacking Iraq
directly is unlikely to allow us to create a Marshall Plan or similar installed
liberal democracy the Bush Administration is hoping for.
Iraq may be just as hard to stabilize as Afghanistan has been.
And Muslim fanatics are unlikely to convert quickly to backing liberal
democracy if it comes from those they perceive as oppressors.

This means the market may pop after a quick takeover of most of Iraq’s
strategic territory, but it also has a lot of realization about the nature of
this conflict to go. The long-term
uncertainty a terrorist global war is likely to create will possibly put a cap
on any rallies and exert long-term multiple contraction pressure on global
stocks.

I don’t suggest trying to play the war financially, because even experts do
not have strong indications of what may happen. Those
who must hedge because they cannot liquidate major positions that would be
affected by war should consider some hedging via crude puts in the event of a
positive war outcome, and to hedge a negative war outcome via leap puts on oil-sensitive,
consumer-sentiment sensitive, and bellwether stocks, as well as calls on global
short-rates. The cost of this insurance
is high and growing though, and high levels of cash are preferred.

Therefore, investors should keep a mix of cash in various currencies (Everbank.com)
and sit on their hands mostly, until the global showdown develops some clarity.

Once war-jitters recede and the outlook is less risk-prone, we believe the
market will launch a strong and more sustained move — though we don’t yet
know in which direction. Watch and wait
for volume, breadth, leadership, and follow-through to
emerge in one direction before
allocating serious capital to either the short or long side.
Caution is still advised strongly.

Our official model portfolio overall allocation remains VERY
DEFENSIVE. We’re now 84% in
T-bills awaiting new opportunities, with one sole long position. Our
model portfolio followed up weekly in this column was up 41% in 1999, up 82% in
2000, up 16.5% in 2001, and up 7.58% in 2002, an average annual gain of over 36%
— all on a worst drawdown of around 12%. We’re now up 0.53% for the year
2003.

Upside breakouts meeting up-fuel criteria (and still open positions) so far this
year are: Port Financial
(
PORT |
Quote |
Chart |
News |
PowerRating) @40.99
(49.09)- w/ a 44.5 ops to lock in
profits, and WebMD
(
HLTH |
Quote |
Chart |
News |
PowerRating) @9.44
(9.54) w/ an 8.5 ops. 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 leadership and
follow-through improve.

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 interactive
training module) 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.

Our advice is simple, but not easy: WAIT!!

Mark
Boucher