Consolidation Likely

May 11, 2001
Mark Boucher

Over
the last four weeks, breadth has been improving, technicals have been
improving, leadership has been improving, and now many more countries are
pushing liquidity indicators higher with lower rates and higher rates of
monetary growth. The market was deeply
oversold and has recovered strongly. The
Dow is now hitting resistance at the 11,000-11,400 zone.
The S&P hit a Fibonacci resistance numberÂ
this week on a Fibonacci date, and is backing off a bit from the
approximately 38.2% it has retraced of the bear market on this rally.
The Naz is also backing off from slight resistance (it has retraced just
23.6% of the decline from the July peak and just 17.5% of the bear market on its
recent sharp rally) and if it breaks over 1310, will also have formed a
head-and-shoulder bottom with a minimum objective around 2600.
A breakout by the Dow over 11,400 will break out over the neckline of a
head-and-shoulders style consolidation pattern. A
breakout by the S&P over the 1280 level also sets up a bullish
head-and-shoulder-bottom formation with an objective near 1400.
We would therefore expect some consolidation around here, possibly for
weeks.

However
if all three averages breakout above head-and-shoulder resistance levels, then
we should definitely see a much more bullish investment environment through the
summer at least. Is this a new bull
market that will send the averages to new highs very soon?
Honestly, it is not yet clear to me whether this is a new bull market or
not. Clearly if the highs mentioned above
are taken out in all the major indexes, then a decent continuation of the upside
move will become highly likely and catchable. Leadership
is improving, which leads me to think that further upside above resistance will
give rise to a rally we can profit from. But
whether this is a new baby or not, we’ll have to just wait and see.

Economically
the question remains whether any degree of easing rates and money-supply
manipulation can bring us quickly out of an excess capacity glut. And we
still have not had the real major breadth thrusts that we would like to see in a
new bull market. But clearly, the bias is
more up than down, and we suspect that breakouts from here will be profitable
for the next few weeks at least. So let’s
slowly increase allocation to longs as valid signals develop and see how well
the move can last, whether this is a bottom of monthly or annual proportions.

Leading
markets are now mostly positive, though copper is behaving badly.
But bonds has completed a large, weekly double top, and Lumber has
exploded higher out if its sloppy double-bottom base.
So the economy is still giving slight advance indications of starting to
turn. These leading economic gauges are
now in a mostly positive mode.

Continue
to watch our breadth indicators carefully for signs of a REAL rally developing. Â Look for
another one or more of the following breadth tools to indicate a
possible strong leg up before getting too excited about buying stocks again: Â 1) the five-day
MA of up volume being greater than 77% of the five-day MA of total volume on a day after the low has been made; Â 2) the
11-day MA of advances are >1.9 times the 11-day MA of
declines; Â 3) up volume/(up volume +
down volume) is >90% on a given day; Â 4)
the S&P rises by 2.75% or more on a given day and 70% of issues traded
advance on the NYSE; Â 5) After the
fifth day following a market low price, we get a strong follow-through day, a day
where two or more of the major averages are up more than 1% on volume that is up
from the prior day and at least 20% above the 50-day MA of volume; Â 6) finally, and most importantly, that we get a large number of breakouts
to new 52-week highs by stocks that are strong EPS and strong RS leaders
breaking out of bases that are four-plus-week solid bases on strong volume.

Let’s
look at some numbers from the week. New
Highs vs. New Lows on our RS/EPS lists were
12/2, 30/3, 33/2, 22/1 and 22/2 — as new highs continue to dominate but are
still not consistently above 20, while new lows are almost non-existent.Â There
were roughly 12 breakouts on the upside to new highs of stocks on our Top RS/EPS
New Highs lists, with only 1 breakdown on the downside of a four-week-plus consolidations on our Bottom RS/EPS
New Lows lists. More significantly, there
were another four close-calls on the upside this week along with one stock that
gave a valid buy signal TRC Companies
(
TRR |
Quote |
Chart |
News |
PowerRating);yes”> Close calls are stocks almost meeting our criteria that broke out
of sound bases. Of course, a truly good
environment would show five or more times this number of breakouts with dozens of
close-calls or stocks actually meeting our criteria breaking out. So
while the opportunities are far from abundant, and the environment not yet
nearly optimum, the long side has been improving steadily.Â

Let’s
take a quick look at this week’s valid breakout pattern in TRR.
TRR is in the pollution-control group, ranked in the 94th percentile and
consistently in the top 20 on Investors’ Business Daily’s tally of
leading industries. Last quarter’s
earnings were up 71% over a year-earlier’s similar quarter, with the prior
quarter up 73%, and earnings up this quarter 0.29 vs. 0.26 in the prior quarter.
That makes it qualify as both a consistent grower and a turnaround
situation earnings-wise. EPS is 99 and RS
is 99. The stock broke out of a
cup-and-handle with a handle consolidation right near the top of the range on a
very strong thrust pattern with near-record volume on the breakout.
The stock’s PE is 37, nearly 1/2 of the least of the last two quarter’s
earnings growth and far less than 70% of the long-term growth rate of 110%.
Debt is nearly too high at 39%, but a slightly higher debt ratio is
common in the pollution-control industry. Funds
are 13% and climbing, just as we would desire. So
we have a stock that meets all our criteria breaking out of a valid
cup-and-handle pattern on good volume and a thrust pattern.
We bought at 36.32 and are using a 31.5 ops just below the handle
support.

Our
overall allocation is still DEFENSIVE with 0% short and 25% long and the
remaining 75% 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 are now
down about 0.7%, with a mostly cash position.Â Â Â

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 and course “The
Science of Trading.” 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.
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, and are now as
defensive as possible.

On
the downside, 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: 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. Here, too, remain
cautious by only adding two shorts in a week, until we get more consistency
in the number of downside breakouts in a given week off of our Bottom RS/EPS New
Lows lists.Â

When
valid breakouts of up-fuel or down-fuel stocks become abundant again, we’ll
pounce with both hands — for now we’ll gently ease in unless the environment
begins to improve. One of the toughest
things for traders and investors to do, is to not worry about missing a bottom.
Bottom-picking is not the path to reliable and consistent strong gains!
What is the path is pouncing on reliable opportunities when they develop
and waiting for reliability before committing much capital.
Remember –– when a clear uptrend
begins, we’ll catch up to the gains since the bottom by being in the leading
stocks a few weeks or months after the bottom is in.

Â Â Â Â Â Â Â Â Â Â Â

Consolidation Likely

BUY THE FEAR, SELL THE GREED

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