Consolidation Or Correction Off Resistance Likely

• March 22, 2002
• Mark Boucher

After
last week’s brush off of key
Fibonacci levels on Fibonacci dates, many other indexes appear to also be
nearing resistance over the last few weeks, and into this week.
The S&P is hitting the 1180-1200 level, the NDX is hitting 1800-2000,
the Russell 2000 is hitting 500-530 resistance, and the Dow has hit trend-channel
resistance of a trend channel in force since early December.
With this much plurality of resistance in so many parts of the U.S.
market, it becomes more probable that the market will continue to consolidate or
correct in the coming week or even weeks.

A
breakout of all of these resistance levels would be a very bullish indication.
Investors should note, though, that an ever-broadening plurality of
commodity, commodity currency, and foreign stock markets are continually
confirming the recovery/brief-bull-market scenario over the intermediate term.
And so far, declines are on poor volume, a positive sign.
Keep your eye out for 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 to make this a totally confirmed
bull move. This would also be a welcome
announcement of a new bull leg up, though as we have said before, in this
less-than-normal bull move, we might not get such breadth.

The
market is still positive enough for me to allow more than two stocks per week to
be added to the long side — but we may not get such positive action for
awhile. Watch the strength of this global
rally carefully to see if the global leadership holds up again on this
correction — Asia (x Japan), Eastern Europe, Latin America, global small cap
value, and U.S. small cap value, along with junk bonds and Emerging Market Debt
(which we should begin phasing out of on new highs). 

Outside
the U.S., a broad plurality of markets are now giving the all-clear signal. Most
global markets we follow, developed and emerging, have crossed above their
200-day moving averages, or are very close, and also have a favorable interest
rate climate. Over the last few weeks, most European markets have joined
the global rally and are now bullish via our global models. The problem with most European markets is that value is not very good. Value in Europe is substantially better than in the U.S., where the
markets are substantially overvalued now, but there is not good value in Europe
like there is in Emerging markets. Germany
shows the best value, but even there it is only neutral valuation.

Nonetheless, momentum and breadth have turned positive on most of the
European markets, and they will likely outperform the most overvalued market,
the U.S. major indexes. And the Australian
and New Zealand dollar have had minor breakouts to confirm the global party as
well. Copper has tried to breakout. Now a majority of economically sensitive commodities and commodity
currencies have flashed at least minor breakouts, making some sort of global
economic upturn likely.

We
have suggested that aggressive investors be exposed to areas such as Emerging
Asia (x Japan) and Eastern Europe, and Latin America, as they have been the
leaders going into this recovery. Now it makes sense to even to slightly broaden
exposure to some developed European nations (in the small cap value sector). Remember that the U.S. market is only likely to correct
50%-68% from here
to its 2000 peak levels — not make a new high. 1965-1982, not like the
secular bull moves of 1982-1999.

In addition, most U.S. equities are extremely overvalued, as are most
European markets (though not as much as the U.S.). The value and the real bull move is in Emerging Markets, not developed
ones. In Emerging markets, value is
good and appreciation potential and earnings growth changes are much better. Aggressive investors should continue to emphasize Asia, Eastern Europe,
and Latin America, junk bonds, and global small caps with probably about half
their portfolios. Right now, this
is where the action and potential are. Even
though on a macro viewpoint the U.S. is not the place to be, we still think that
our long/short strategy in growth stocks with decent value will be able to
show good returns this year. But
realize the U.S. market is likely to be volatile, and our approach will not be
able to avoid some of that volatility — so expect more frequent and larger
drawdowns than we’ve had so far.

This
week we had one close call in Stratasys
(
SSYS |
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PowerRating), but no new trades. Once this mini-correction has run its course, we would expect more
opportunities to develop. Wait for
them before increasing exposure –– and
ONLY in leading industries! With
commodity prices moving off their bases, economically sensitive currencies
showing strength, and global bonds heading lower, we changed our posture to
slightly more bullish in our model portfolio intra-week, allowing the addition
of more then two names per week in leading industries.

Top
RS/EPS New Highs continued last week’s bull-market-correction pace (23, 25,
33, 32, 25). Still, reaching 20 or more per day consistently is better than we
have seen in the past. Breakout numbers were pathetic with only 11 breakouts for
the week, but the quality of the breakouts fell from the prior week without a
valid signal. We also had two
stop-outs in Ryland Group
(
RYL |
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PowerRating), where we took strong profits, and in
American Woodmark
(
AMWD |
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PowerRating), where we took a
small loss — both in the leading building industry. We suspect that we’ll get new buy signals in this industry in the weeks
ahead. Bottom RS/EPS New Lows were
almost nonexistent this week, with just 26 total and only five real breakdowns out
of valid flag patterns or cup and handles of more than four weeks, with one
close-call on meeting all our criteria.
 

Our
overall allocation remains PRETTY DEFENSIVE, with 68% 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 — all on a worst drawdown of
around 12%. We’re now up
about 2% for the year 2002.

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.Upside
breakouts meeting up-fuel criteria (and still open positions) so far this year
are: Ryland Group
(
RYL |
Quote |
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News |
PowerRating) @64.30 — out on 85.50 ops;
American Woodmark
(
AMWD |
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News |
PowerRating) @65.485 — out 62.05 on 63.75 ops;
Crown Group
(
CNGR |
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Chart |
News |
PowerRating) @8.60 (9.1) w/7.90 ops;

Garan
(
GAN |
Quote |
Chart |
News |
PowerRating) @45.60 (49.8) w/45.9 ops; Coventry
Health Care
(
CVH |
Quote |
Chart |
News |
PowerRating) @25.85  (27.35) w/25.4 ops; and
Lands End
(
LE |
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Chart |
News |
PowerRating) @52 (45.09) w/42.50 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. 

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.

The
broad plurality of messages supporting the global recovery scenario continues to
build, despite many US indexes reaching near resistance levels. Globally, investors should continue to become less defensive. We expect
the markets to be able to eventually clear the highs of the last two weeks as a
better economic environment presents itself. Commodities and commodity currencies are now joining the chorus of
markets pointing to better economic times ahead. Aggressive investors could focus part of their portfolios on taking
advantage of the emerging commodity bull market, as well as focusing about half
their portfolios on leading sectors of this global recovery in Emerging markets
and leading small cap value stocks. We
believe a better environment is developing for our long/short approach this
Spring.