Here’s what I’m watching in 2006
Another year is coming to a close and
it is time to look forward to 2006. We have advised less than
aggressive allocation to global equity markets during this past year. We
continue to suggest exposure to global equities, but less than normal, despite
our suspicion that global markets will do better in 2006 overall than they did
in 2005.
There are risks. The cyclical bull market is around 39-months
old, in the range of the average top. In the Presidential Election Cycle, this
is a second weaker-than-normal year, just as 2005 was. And we’re coming close to
a negative seasonal time frame after the new year ends. In addition there are
some breadth problems in the US market. New Highs/New Lows peaked in 2004 and
have trended steadily lower. A/D lines are not making new highs along with many
indexes. Volume accumulation has weakened markedly. It is quite possible that
Jan-March will be a fairly difficult market environment.
The ratio of coincident to lagging indicators is warning of a
slowdown toward the middle of 2006. Housing appears to be peaking, and this has
been the impetus behind strong consumer growth during the last few years. Fed
rate hikes continue and the yield curve looks set to invert in 2006. There is
evidence that US consumption is starting to slow as well. And twin deficits of
historic proportions in the US remain a reason for concern. This is therefore
NOT the Nirvana environment for equity investors, where the global economy is in
the midst of, or emerging from recession, while interest rates are dropping
rapidly and stock prices are cheap.
And yet, our best guess is probably that 2006 will be a half
decent year for equities in the US and globally. The world is in the midst of a
productivity boom coming from technology and the entry of a vast new pool of
labor that is likely to keep a lid on core inflation in the world and prevent
the type of strict liquidity squeeze that has preceded nearly every recession in
the 20th century. Our guess is that both the housing slowdown and consumer
spending slowdown in the US will be mild and not sharp. Ditto with any pressure
on the dollar that develops, as Asia has no choice but to prevent a dollar
collapse. And while a consumption demand slowdown in the US may develop mildly,
a pickup in consumption in Europe, Japan, and China are likely to offset it to
at least some degree.
Therefore with more caution than normal allocation we still
like some of the main themes we see evolving in global equities, and suggest
investors either trade around intermediate trends in them, or else use weakness
to buy them. These include Korea, Japan, Brazilian banks, Emerging Markets,
South Africa, metals shares, energy (particularly oil services), industrials,
resources plays (watch for grains in 2006 perhaps), and China.
Our basic strategy of buying strictly only those stocks
meeting our rigid criteria and selling short those doing the same on breakouts,
had a mildly decent year this year and beat the market with extremely low
average allocation. We suspect 2006 will be similar in that this is NOT likely
to be the environment where lots of such opportunities materialize.
Over the past two weeks in our Top RS/EPS New Highs list
published on TradingMarkets.com, we had readings of 44, 34, 26, 27, 44, 66, 77,
and 22 with 28 breakouts of 4+ week ranges, one valid trade in
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close calls. This week, our bottom RS/EPS New Lows recorded readings of 16, 9,
29, 47, 36, 29, 25, and 22 with 18 breakdowns of 4+ week ranges, no valid trades
and no close calls. The “model†portfolio of trades meeting criteria is now long
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treacherous and we are chickens when it comes to risking principle unless it
looks like the weather is clear.
We therefore continue to suggest mild allocation to top global
themes, and for investors to expect volatility and less than optimum markets.
There ARE big risks. A dollar or Yen crisis, a US consumption or housing crisis,
or increases in Asian inflation are the primary concerns investors should watch.
However it appears more likely that these problems will be mild and that markets
will continue an irregular march higher to me at this time. Therefore cautious
exposure, trading in and out with minor trends, is probably yet again the best
approach to 2006. We wish everyone a very happy holiday season, and a very
prosperous New Year in 2006!! Next Report in the New Year.
Mark Boucher
Mark Boucher has been ranked #1 by Nelson’s World’s Best
Money Managers for his 5-year compounded annual rate of return of 26.6%.
Boucher began trading at age 16. His trading helped finance his education at the
University of California at Berkeley, where he graduated with honors in
Economics. Upon graduation, he founded Investment Research Associates to finance
research on stock, bond, and currency trading systems. Boucher joined forces
with Fortunet, Inc. in 1986, where he developed models for hedging and trading
bonds, currencies, futures, and stocks. In 1989, the results of this research
were published in the Fortunet Trading Course. While with Fortunet, Boucher also
applied this research to designing institutional products, such as a hedging
model on over $1 billion of debt exposure for the treasurer of Mead, a Fortune
500 company.
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.
For those not familiar with our long/short strategies, we
suggest you review my book The Hedge Fund Edge. 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.