Here Are A Few Technicals To Keep A Close Eye On
The major averages have begun
to correct and consolidate since breaking their March/April resistance levels of
910 in the S&P and 1450 in the Naz. Now the S&P has begun to retract from its
October-January resistance level of 955 and the Naz has fallen back below its
October-January resistance level of 1520. Technicals and fundamentals are urging
equity investors to use caution in the next week. The VIX is approaching 20, a
historical flashpoint that the market is overbought and a correction is
near. Also, watch other market technicals, such as the five-day average
advancing volume over total volume, the 11-day average advancers over decliners,
and the up volume over sum volume. As these technical indicators decrease,
become more cautious with equity allocations and as these technical indicators
increase, become more aggressive.
We continue to watch for
follow-through up days and breakouts by the averages that will confirm if this
bear market rally has legs and will be of stronger and longer duration than any
since the ’99-2000 peak. High-volume down days in conjunction with lowered
corporate profit expectations or geopolitical crises could stop the current
market churn for a further correction.
The market became a bit weary
this past week following harried comments by the Fed regarding deflationary
pressures. Although there is little the Fed can do to stimulate the market by
dropping interest rates, Greenspan did assuage the market by saying that the Fed
could still buy treasury bonds to curb deflation and stimulate the
economy. Market forces should work this situation out, though.
With the weakened dollar and
subsequent increase in American exports and decrease in European exports, money
is beginning to flow back into the US. The central banks of foreign countries
should be pushed to lower interest rates so that capital does not continue to
leave their countries. The market is bewildered by the euro zone’s reluctance
and tardiness in dropping short-term interest rates, but the current trade
imbalance will force the euro zone to drop rates by at least 50 basis points in
June. Additionally, the weak dollar should provide economic stimulus by
increasing GDP by 1% in 2003, so from a US market perspective, the slower the
euro zone is to loosen monetary policy, the better. This stimulus, along with
the lowest interest rates in 40 years and maximum fiscal thrust, should push the
US economy to accelerate in the second half of the year. A coinciding increase
in the expected return on US assets as compared with foreign assets should stop
the strength of the euro and the yen as capital flows into the US. Watch market
action at current resistance levels as well as our Top RS and EPS list for weeks
with more than 20 breakouts of four-plus-week consolidations for confirmation of
a market breakout from this consolidation period.
Continue to watch for signs of
an increase in capital equipment spending as the most important proxy for
economic growth. We are getting economic signals that both capacity utilization
and capital spending are increasing simultaneously, exactly what we are looking
for in an economic turnaround. As bonds continue to make new highs, the cost of
capital continues to decrease, and the gap between the return and cost of
capital increases, so businesses should take advantage by increasing capital
equipment spending.
Last week the fixed income and
equity markets were diverging in opposite directions, begging the question,
“Which market is right?â€Â The answer this past week was bonds, as bonds made news
highs and the rally in equities dried up. We still think that with the 10-year
treasury yielding a very low 3.5%, yields have little downside and that the
answer is more likely to be equities over the intermediate term unless a greater
macro-level event takes place.
The biggest terror attack on US
citizens since Sept. 11 occurred last week in Saudi Arabia and had little market
consequence at the time, but this event has slowly taken its toll on sentiment
as the Department of Homeland Security increased its alert status to orange
ahead of the Memorial Day weekend. The market hasn’t been on watch like this
since the first week of the war in Iraq. Otherwise, watch the leading economic
indicators for further signs of improvement before bond yields begin to
increase. More opportunities in high growth equities should become available if
the market can catch some positive momentum. Pay close attention to breakouts
from leading growth groups such as biotech, internet, telecom, software, and
other companies with q/q EPS growth over 25%, low institutional ownership, and
low PE/Growth ratios.
Investors should continue to
add exposure as trade signals are generated. A high-volume, strong breakout of
the major indices above intermediate-term resistance levels will turn us more
aggressively bullish. All of the conditions are in place for a stock market
rally, now we await market follow through.
Since March 2000, the world index is down over
42%, the S&P over 39%, the IBD mutual fund index is down over 60%, and the
Nasdaq has crashed over 70%. Meanwhile, since March 2000, the long/short
strategy we summarize and follow-up each week in this column has made more than
44% on a worst drawdown of under 6%. While
this recent performance is underperforming our long-term investment returns, 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.Â
Our official model portfolio
overall allocation remains SOMEWHAT DEFENSIVE. We’re now 32% long, with 68% cash
in T-bills awaiting new opportunities. 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 3.71% for the year
2003.     Â
We had readings of 54, 47, 29,
23 and 15 in our Top RS/EPS New Highs list, accompanied by three breakouts of
four-plus-week ranges, NO valid trades and NO close calls. Disappointing,
considering the number of new highs this past week, but remain patient and good
breakouts of solid bases will come if the market continues to churn through this
consolidation period. Look to be more aggressive with your stock selection when
more positive market breadth indicators appear, particularly a week with 20 or
greater new breakouts of four-plus-week ranges. We have been lucky enough to
take advantage of strong breakout opportunities that have presented themselves
in the past two months and await further opportunities if the market remains
strong. Bottom RS/EPS New Lows were almost nonexistent last week as they have
been since mid-April showing low readings of 1, 0, 1, 0 and 1, no breakdowns of
four-plus-week patterns and NO close calls.
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 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.
Upside breakouts meeting
up-fuel criteria (and still open positions) so far this year are:
Garmin
(
GRMN |
Quote |
Chart |
News |
PowerRating) @34.79 (44.98) w/41 ops;
STET Hellas Telecommunications
(
STHLY |
Quote |
Chart |
News |
PowerRating)
@8.64 (9.19) w/8.2 ops (ignore the bad low tick on 5/15);
Avid Technology
(
AVID |
Quote |
Chart |
News |
PowerRating) @25.1 (27.98)
w/26.0 ops; and Cyberonics
(
CYBX |
Quote |
Chart |
News |
PowerRating)
@22.46 (22.06) w/20.5 ops. Continue to watch our NH list and buy flags or
cup-and-handle breakouts in NH’s meeting our up-fuel criteria — we’ll continue
to advise adding only two stocks per week that are in clearly leading groups
until we get clear breakouts in all the averages.
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)
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
excited about the environment on the long side. However, be patient and be sure
to only buy strong breakouts that meet all of our criteria. If indeed a
multi-month bull move is in the making, the best trades are yet to come, and
waiting for valid breakouts will allow you to substantially beat the moves of
the averages even though most trades come after the move is well on its
way. Closely watch the leading economic indicators and how they affect sentiment
regarding economic growth for the remainder of 2003 and into the
future. Investors are once again looking for a second-half recovery, and any
delay could result in market apathy where the market range trades and never
breaks major resistance levels for a long period of time. Better times seem to
be materializing here with the weakened dollar, low interest rates, increasing
sentiment and tax-cut stimulation. Now corporate profits and capital investment
must come through by meeting and exceeding expectations.