Get Defensive–Here’s Why

  • April 29, 2005
  • Mark Boucher

Critical
Level Test Continues

We await a break by the Nasdaq
below 1885,  by the SPY below 113, and below 100 by DIA’s to confirm a new leg
down in progress and establishes a clear downtrend here.  We’re getting close,
and should this develop investors should move to an all-out defensive position. 
Investors and traders should already be defensively allocated without any net
long exposure.    

Defensive groups we’ve been
recommending for aggressive traders to pair against shorts in weaker groups
continue to show RS, just as the weakest groups we have been highlighting
continue to deteriorate.  The best long-side groups appear to be Aerospace and
Defense, Soaps and some staples, health care (a broadening range of groups here
such as hospitals, HMO’s, managed care, pharms — health care is our favorite
RELATIVE sector), telecom, and non-cyclicals;  while the best short-side groups
appear to be auto equipment, financials (S&L’s and mortgage services
especially), home retail, chemicals, electronics and computer retail, RV
building, and home appliances.

Economic indicators are
beginning to reveal what the stock market has been signaling all quarter — a
slowdown in growth is developing.  Yet the Fed is likely to raise rates next
week 25 bp’s and to continue to do so until CLEAR economic weakness develops. 
This is what we have described as a dangerous phase for equities, and even for
commodities when rates are rising while markets are falling.

The dollar rally we’ve talked
about for months, seems to be continuing, and with this and the less supportive
action in bonds, commodities are taking a hit as well.  We believe this is a
correction in a secular bull market for commodities and gold, but it appears to
have clearly arrived.


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 15, 22, 34, 28, and 22 with 15 breakouts of 4+ week ranges, no
valid trades and no close calls.  This week, our bottom RS/EPS New Lows recorded
readings of 26, 43, 57, 38, and 66 breakdowns of 4+ week ranges, no valid trades
and no close calls.  Valid signals remain in place in LCAV and CHTT on the long
side and ALO and BOBE on the short-side.    Notice that neither new highs or new
lows are exceptionally strong this week. 


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.


A big part of keeping risk down and profiting consistently in the markets is
knowing when not to risk capital much.  Only investing substantially when the
odds are substantially in your favor is critical.  There are some relative value
themes that investors and aggressive traders could exploit here, but most
investors should be mostly out of the market and awaiting better odds
opportunities here.

Mark Boucher