Eight More Things To Watch For As War News Takes Markets Hostage…

• March 27, 2003
• Mark Boucher

As the
war officially enters its second week, there have been few major
developments and serious battles to evaluate. The
coalition troops are making remarkably quick progress, though they are probably
behind schedule. They have faced few
serious obstacles to their drive toward Baghdad.
Originally, the coalition had planned the attack on Baghdad to begin
March 29, but it appears they have revised that strategy and will delay and try
to focus more on other cities (like Basra) before attacking Baghdad with full
force. They will likely need more troops
as well for Baghdad.

Iraqi troops have embedded
themselves behind religious buildings and civilian populations to prevent aerial
destruction. They have shielded
themselves with women and children at times. The
coalition has yet to figure out how to handle this problem, and probably will
need to change strategy. As it is now,
the coalition doesn’t want to create major civilian casualties, so it bypasses
high-population areas despite the fact that forces are hidden in them.
Groups of 8-20 Iraqi troops then launch small guerrilla attacks on supply
lines and troops left behind to hold back the Iraqi forces hidden in population
areas. So far, it’s a war of hiding,
guerrilla attack, and potshots at US troops to try and get the casualty rate
high enough to foment public outcry for the Iraqis.

Syria is making troubling
noises and allowing youth to join Iraqis, a situation which bears watching.
Chemical-weapons suits and antidotes have been found at multiple
locations and recon believes there are chemical weapons held by troops in Al Kut
and Baghdad. So far, there are few major
surprises and the significant battles lie ahead.
The coalition has been disappointed with the lack of uprisings and
revolts against the Iraqi regime, while Iraq has failed to mount a serious
military movement against coalition forces to date.
The key things for investors to watch at this time in the war appear to
be as follows.

Watch for
these events of Operation Iraqi Freedom: 

1. The markets are likely
   hostage to war news and changes in the winds, so the great breadth on the
   upside since the war started could turn on a dime on surprisingly negative
   news; 

2. Watch for evidence that
   Syria is unofficially joining the conflict or further evidence of more
   Iranian supplies reaching Iraqi troops (potential negative for markets);
   

3. Watch for the use of
   chemical, biological, or radioactive weapons (or finding of factories) that
   would be a negative shock to the markets; 
   

4. Watch for indication of
   civilian surrender or military surrender in non-Baghdad population centers
   that could boost markets; 

5. Watch for the iron-triangle
   to prolong the conflict and for the battle of Baghdad to drag on and
   potentially become guerrilla warfare; 

6. Watch for missiles or
   terrorist attacks on the US, US installations abroad, on those nations
   assisting the US, and on Israel, which would be negative for markets;  

7. Watch for any insurrections
   or attempted coups that would be positive for markets; 
   

8. Watch for negative market
   reaction from peace protests either in the West or in the Middle East. 

Investors need to maintain
perspective and discipline and remain unduly cautious with regard to
investments.
The War will not be over, even when Baghdad falls.
Victory in Iraq starts the process of undermining the foundations of al
Qaeda and other radical Islam terrorist cells, but Iraq is only one of many
support centers for terrorism. There are
also huge terrorism problems in Pakistan, Iran, Saudi Arabia, Syria, North
Korea, Albania and elsewhere, where al Qaeda remains substantial, not
necessarily with the blessings of the government in power.
Therefore, regardless of how quickly the Iraqi Campaign ends, there will
likely only be a pause of a year or less, before the next target for campaign
must be initiated — and it could well be much faster than that if events move
quickly.

The markets will be reacting
probably violently in many directions from news of the battles in Iraq.
So far, there has been substantial and credible breadth on the upside
that has been stronger than any since the 2000 peak. 

I don’t think the markets or
the coalition realize how difficult it will be to develop democracy and
stability in Iraq, even after a successful military campaign.
And I don’t believe the markets understand that this is not a war like
the early 1990s version — it is a campaign in an on-going global war on
terrorism that will take many many years to complete. (The
Bush Administration estimates 10 years MINIMUM.) 
I would be surprised if PE ratios won’t trend down, as the markets come
to realize the truth about the duration of global military conflict.
So treat rallies with breadth and leadership and follow-through a bit
more cautiously than normal in this environment, even if they develop, and keep
in mind that the great bear market that started in 1999 in global markets may be
far from over, despite temporary reprieves. In
a bear market, most surprises are negative.

Was the prior week’s huge
breadth a catchable bottom in the making? Quite
possibly. We had a 9/1 downside breadth
day followed by a 9/1 up breadth day, two follow-through days to the upside, and
many of our models are flashing buy signals. Breakouts,
follow-through and leadership have not yet developed completely, but appear in
the making — although I strongly suspect this will not happen until resolution
of the Iraqi campaign is near at hand.

For investors, HEAVY
cash positions are advised during this conflict — watch the fireworks from
afar in T-bills — that’s our version of Operation Investor Freedom.

Investors should keep a mix of
cash in various currencies (Everbank.com) and sit on their hands, mostly, until
the new campaign and health of the global recovery both develop more clarity.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. 

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 39% on a worst drawdown 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 9 out of 10 traders have been big losers. 

Our official model portfolio
overall allocation remains VERY DEFENSIVE.
We’re now 84% in T-bills awaiting new opportunities, with two sole long
positions. 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 0.1% for the year 2003.   

To our daily Top
RS/EPS New Highs list the entire rally from the 7/24 and then October lows
never even registered on the radar screen having mustered up just ONE
solid week of consistent +20 or higher readings since 7/24, though this
past week was close. Bottom RS/EPS New
Lows are plummeting and the market now has a solid upward bias and may have
reached a decent bottom.  We had
readings of 30, 60, 5, 23, and 30 new highs last week in our Top RS/EPS New
Highs list, accompanied by 18 breakouts of a 4+ week range, though
significantly, with no official trades or even close calls. 
Bottom RS/EPS New Lows last week showed readings of 
2, 1, 3, 2, and 4, accompanied by just 1 breakdowns of 4+ week patterns
without any clear close call on the short side. The
bottom-line is that highly reliable low risk opportunities remain scarce in this
uncertain environment.

For
those not familiar with our long/short strategies, we suggest you review my book
The
Hedge Fund Edge, my course “The Science of Trading,” my
video seminar, where I discuss many new techniques, and my latest
educational product, and interactive
training module. 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 US 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: Port
Financial
(
PORT |
Quote |
Chart |
News |
PowerRating) @40.99 (48)- w/ 
a 44.5 ops to lock in profits; and Garmin
(
GRMN |
Quote |
Chart |
News |
PowerRating) @34.79 (36.07) w/ 30.9 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.

Investors and traders should be
on survival strategy here. Hopefully, the
little hiccups in the first week of battle will convince you that the markets
can turn on a dime in either direction, depending upon factors which are
impossible to predict in Iraq. Clearly
this is not the kind of reliable situation a true investor is looking for, in my
opinion. Stay heavily in cash and aware
of the risks, and when there is a clearer path toward resolution that is
signaled by breadth, follow-through, and leadership, then investment strategies
will pay off big.

Mark Boucher