Five Excuses For A Correction

February 6, 2004
Mark Boucher

For
months weâ€™ve been talking about the typical cyclical bull market correcting
during the transition between monetary stimulus being the main
impetus toward stock gains and real economic gains. Weâ€™ve been theorizing that
such a transition was close at hand. We may now finally be in such a
transitionary correction in global markets. A number of indices have made
short-term head-and-shoulders tops and double tops and are following the global
leadership down, which tends to confirm the start of a more meaningful
correction than we have witnessed since last March.

IF
this is indeed a normal cyclical correction, the S&P could drop to the 99-105
range, the MSCI global stock index could drop into the 215-235 range, EPP
representing Asian stocks could fall into the 59-67 range, ILF representing
Latin America could fall into the 50-55 range, and EEM representing Emerging
Markets in general could fall into the 140-150 zone. A normal cyclical
correction would last around 1-3 months. Further downside on strong volume would
be necessary to confirm that we have indeed entered a normal correction, so
watch the major indices carefully.

Likely excuses investors would use to take some profits and cause a correction
include:

A slight slowdown of growth
acceleration in China.

Asian disease worries.

A dollar correction.

Fed repositioning to be able
to tighten sooner than expected.

A period when investors are
uncertain that job growth will materialize.

^Next^

We donâ€™t yet see anything to
suggest that a further rally to new highs will not eventually develop as the
recovery becomes global and self reinforcing, at least for a brief period. In
the meantime we would stay pretty cautious here.

Consumer staples like
(
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seem to be outperforming as do health care and other defensive industries. When
cyclicals begin outperforming again, then the next leg up will likely begin, but
investors need to be mindful that this is likely to be much less dynamic and
broad-based than the rally since March. Valuations globally are now not
favorable almost anywhere (save Taiwan and this is because of China flare-up
worries in the approaching election). US market valuations are quite poor, so
investors should not be expecting any multiple expansion. Yet liquidity is still
ample and stocks should not move up less than earnings growth until interest
rates start heading up in earnest â€” and that is probably not until near the
election.

Our US long/short model is fully on the sidelines and we continue
to suggest investor caution until either new highs in a broad array of global
bourses or until corrections run to the levels indicated above. 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) â€” 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 10, 15, 28, 25, and 21 (another new high
reading below 20), accompanied by 3 breakouts of 4+ week ranges, with no valid
trades and no close calls. Internal strength has deteriorated, though not
rapidly yet. 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, 0, 0, 2, and 1, with one breakdown of a 4+ week
ranges, 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 donâ€™t see internal evidence of a serious correction, nor do
we see good 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 U.S. 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 of 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.

Mark Boucher

Five Excuses For A Correction

BUY THE FEAR, SELL THE GREED

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