Eleven Major Themes You Should Be Monitoring
While the easy portion of the liquidity-induced global
equity rally is past, and the next leg will require employment gains
and further earnings gains to move a much slower pace than last year’s rally,
investors should keep their eyes on the major themes in global markets that have
led since March of last year.
-
Resources–particularly the base metals and
base-metal producers have been on a tear. This recovery is the first since
WWII where China’s massive importation of resources has exerted such massive
influence and has become second only to the US’s influence on the global
economy. As the recovery broadens and is joined by Japan and Europe, the
recovery is likely to become synchronous for a period of time. Normally, a
synchronous recovery that is liquidity-induced leads to shortages and runups
in industrial materials. This could be the biggest runup in industrial
materials since WWII as it will feature not only regular global demand but
massive demand from China and Asia that
was never present before. Energy is in a similar boat. Most resources have
been coming off of highs since early January, and are now consolidating. Yet
base metals themselves continue on a tear, though they are approaching
multi-year resistance levels. Investors should buy breakouts and corrections
in areas exploiting this theme. -
Emerging Markets—emerging markets in Asia led
this recovery and are the most leveraged to exploit global economic
recovery. Emerging market equities are still relatively inexpensive on a PE
basis and have stronger earnings gains potential than those of developed
markets. Russia is both a resource play, an undervalued play, and a recovery
play. Eastern Europe has the strongest growth potential
in Europe, though it has become overvalued recently. Latin America
typically picks up relative strength when commodity prices are strong—and
since commodity prices are likely to be stronger than any other cycle down the
road, these are good areas to look for companies and sector plays. -
China Region—one of the clear secular
themes developing is the emergence of the China region as
the dominant global economic power. The
China region is arguably the second-largest economy in the world, and
certainly among the top 5. Yet the region is growing at 6%-10% annual rates.
China has moved from being mainly an exporter to the
West to being the second-largest importer of goods in the world. Asia
is being propelled by internal growth of trying to supply massive Chinese
demand for resources and materials. When the global markets are moving up,
China should outperform, and is likely to experience mini-bubble after
mini-bubble later this decade. China is currently in a mini soft-landing,
where it is striving to selectively slow growth in overdone sectors. Investors
should watch this theme and its rotations for major plays when global markets
are moving up. -
India—India cannot grow as quickly as
China because it is over-regulated, but it is still a massive emerging
economic power that is growing much faster than
the developed world and is still emerging. -
Real Estate—as long interest rates stay
down (at least until the election), real estate should outperform. We like
global and US real estate plays. Further, we DO NOT see
evidence of a bubble. Bubbles are characterized by massive runups in
prices near the end of the move. This has not been the case in real estate. We
expect real estate to outperform while rates are not moving up rapidly, and to
surprise by staying relatively firm when rates do begin to rise. Only when
real rates start to become negative and global economic crisis looms do we
expect real estate to do poorly. The best real estate plays globally are in
the emerging markets. There are Asian REITS like EGLRX and Rodamco that
investors should monitor. -
Precious Metals—Massive monetary infusion
on a globally unprecedented scale has coincided with a leading new bull market
in precious metals. Silver has started to outperform gold. Investors should
accumulate gold, silver, palladium, and platinum basis cash, and play the
cycles in stocks. Mining stocks are wildly volatile, but should be one of the
major themes investors are trading in and out of for many years to come. Silver
and Palladium are our favorites this year. -
Dollar Bear—Greenspan and the Bush
Administration are in agreement that they have no problem letting the dollar
fall. The euro or its equivalent has fluctuated between 0.64 and 1.45 since
1970, with the 1985 rally in the dollar being as far from this mean as the
euro rallies of 1980 and 1992. The euro will probably test the 1.45 level
eventually, but has had a massive runup and will face policy resistance after
1.30. The commodity currencies have led the bull move,
as we anticipated in this article. But the Aussie is getting overdone and the
NZD is hitting historical resistance. Best bets now are that the Asian
currencies (like SGD and KRW) and the weaker commodity currencies (like RUB
and THB) will play catchup this year. Also look for the interest-rate raisers
like the GBP to outperform the euro and CHF who are possibly still looking to
cut rates. -
European Catchup—Europe is the laggard in
this global economic recovery and its stocks are the
least overvalued of developed equities. European equities are playing
catchup, and small-cap value segments are outperforming in Europe in
particular, just as they have in the US. -
Interest Rate Rising—The secular move down in
global interest rates may be coming to a close. Last year’s huge crash in
global bond markets has stabilized, but is likely a precursor of things to
come on a global basis. Reflation is working and eventually, when inflation
inevitably appears, rates will have to rise and fast. First, rates will
normalize as they are now doing in Australia, New Zealand, Great Britain. Markets
will not like renormalization of rates, but they may be able to hold up
after sharp declines as long as the bond market decline is orderly. However,
when rates begin to move up to head off emerging inflation, the bond market
bubble could make the 1999-2000 stock market bubble look like a picnic. Watch
for shorting opportunities in TLT and other bond market proxies. -
Cyclicals and materials outperform–as long
as the recovery stays afloat cyclicals and materials industries should
outperform, shifting to late cyclicals. Health care and telecom are special
situation industries to watch for outperformance as well. -
Mid-cap and small-cap value—small-cap
outperformance has been a dominant theme since March. However small caps are
no longer undervalued, though they are still likely to show better earnings
growth in the period ahead. As inflation builds, value will begin to
outperform growth strategies, and investors should watch mid-cap value areas
where value is still the best and the cycle is likely to give the best reward.
These are some of
the major themes that investors should be monitoring and using to build
portfolios in this global bear-market rally. Keep your eye on the major trends
(ball), especially as gains this year are likely to be much more difficult than
last year, and as shifts between top sectors could be crucial to investment
performance. The market is tentative and traders need to very nimble and
flexible.
So far our US long/short model is fully on the sidelines and we
continue to suggest investors position in our favorite sectors noted above and
use some caution until stocks meeting our criteria expand in breakout breadth.
Investors should continue to cautiously add stock exposure as trade signals are
generated that meet our strict criteria, as well as allocate to our favorite
segments. Our model portfolio followed in TradingMarkets.com with specific
entry/exit/ops levels from 1999 through May of 2003 was up 41% in 1999, 82% in
2000, 16.5% in 2001, 7.58% in 2002, and we stopped specific recommendations up
around 5% in May 2003 (strict following of our US only methodologies should have
had portfolios up 17% for the year 2003) — all on worst drawdown of under 7%.
This did not include our foreign stock recommendations that had spectacular
performance in 2003.
This week in our
Top
RS/EPS New Highs list published on TradingMarkets.com, we had readings of
55, 28, 62, and 48, with 11 breakouts of 4+ week ranges, no valid trades and no
close calls, but a marked improvement over last week, and a whole week with
readings above 20. Let’s see if this rally has teeth and we can get some
legitimate trade signals in stocks meeting our criteria and breaking out this
coming week. Position in valid 4+ week trading range breakouts on stocks meeting
our criteria or in close calls that are in clearly leading industries, in a
diversified fashion. This week, our
Bottom RS/EPS New Lows remained non-existent with readings of 0, 1, 2, and
0, with one breakdown of a 4+ week range, no valid trades and no close calls.
The short-side breadth remains bleak and it will be important to see if it picks
up here on further corrective activity. So far we don’t see internal evidence of
a serious correction, and we need more internal evidence that a new broad-based
upthrust is in the making.
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, the
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 long 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 did not get to a fully allocated long exposure even
during the 2003 rally.
On the long side, we like the recent close calls from past weeks:
(
PPC |
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(
NFI |
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(
MBT |
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(
GALN |
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(
NIHD |
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PowerRating). We would keep
allocations low until the trend is more certain and emphasize global leaders
noted above until more trade signals are generated and the trend is more
certain.
Until
next week,
Mark Boucher