Here’s What’s Important In This Volatile Correction

March 26, 2004
Mark Boucher

The Naz has now corrected to its 200-day MA level,
and weâ€™ve had two 90% downside volume days. A normal correction could end after
this type of action. Therefore it will be important to see if the US market can
launch a couple accumulation days from here, or whether there will be more
corrective activity after short-covering. Dow Theory gave a bear market signal
for the first time since 1999, suggesting more than a correction could be
developing.

Thus the investment
climate is too volatile and uncertain for investors to make large
one-directional bets. The strongest areas holding up to global market correction
forces are Japan (particularly small cap),
Malaysia, Russia, selected energy, selected resource areas,
silver and
palladium, and real estate/housing (though weakening over the last
few days and needs to be monitored). Gold stocks, Indonesia, and Brazil need to
be watched for potential upside breakouts.

The weakest areas
are airlines, semiconductors, broad Europe, and some tech sub-sectors. Investors
wanting action and some upside potential who are willing to accept the
larger-than-normal risk of the current environment should watch our stock lists
for signals and balance longs and shorts among the above-mentioned groups. Most
investors should be highly defensive until more clarity develops â€” and should
look to other asset classes (commodities in particular) for investment gains.

It will be important to see if job creation takes off as would normally already
have begun at this stage of a recovery. If job growth is only lagging by an
unusually large amount of time and job growth does begin to clearly materialize,
the economic and market environment will improve markedly. If job creation
doesnâ€™t start developing soon, this will be a major disappointment to the global
recovery scenario already priced into stocks.

Chinaâ€™s attempts at slowing growth have failed, and China is beginning a more
orthodox tightening phase. The Chinese economy is highly leveraged and any
interest rate increases will cause sizeable declines in Chinese corporate
profitability, and in stocks. It will be important to see if China can engineer
a modest economic slowdown or it will have to undergo a substantial tightening
cycle. The US and China are the main importing engines of growth in the world
today.

Politics and terrorist actions are a continued concern and could cause shocks to
the markets. Spainâ€™s shift is being followed by other European countries, yet
Europe has yet to tailor a credible response to the global terrorist threat that
is clearly upon the free world. What is needed is a cold-war type solid
alliance, not appeasement. Yet that does not appear in the cards for some
time. There are many elections coming up globally and the terrorist success in
influencing elections in Spain leave the threat of a much higher level of
terrorist action than ever before, globally. Israel and Palestine are battling
back and forth. France has had bomb threats. Al Qaeda has marked Italy as one of
its top next targets.

^Next^

Pakistan is doing a poor job of trying to fight al Qaeda, yet al Qaeda has now
called for the overthrow of the Pakistani government. Syria is close to civil
war with the Syrian Kurds as a soccer game turned into an armed
conflict. Taiwanâ€™s election is being recounted while China mulls over its
response to a pro-independence leader. After a more than two-year â€œwar on
terror,â€ it appears that al Qaedaâ€™s influence in the world has only grown. Bush
is behind in the polls as are many incumbents globally. Protectionist policies
are being proposed all over Europe and in the US. The US, UK, and Europe are
trying to strong-arm the entire free world into tax harmonization and
anti-free-market tax-haven policies. This leaves the markets uncertain and the
environment vulnerable to potential shocks, with threats that many of the main
propellers of the bull market since the 1980s could fall apart.

Reflationary forces have peaked and investors are uncertain about whether
self-sustaining growth has really taken hold in enough places to fuel further
gains, or whether, like in Japan after its bubble popped, massive liquidity
infusion only lasts as long as the spigot is on at full steam, but slows down
thereafter.

In this environment investors should stay cautious therefore, as many
uncertainties need to be ironed out before a genuine new leg up is likely to
develop. Wait for more evidence of accumulation days in the major averages, and
more broad-based breakouts in top global themes. It would be nice to see
recoveries in Thailand, India, Tech, and other global leaders of last yearâ€™s
bull move begin as well.

Our opportunistic US long/short model has been fully on the sidelines all year,
and we continue to suggest investors use some caution until stocks meeting our
criteria expand in breakout breadth (we have one official short-trade open right
now). 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 on breakouts and signals as advised above. 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
21, 23, 14, 17, and 21, with 6 breakouts of 4+ week ranges, no valid trades and
no close calls â€” weâ€™re back into trading range type of readings once again. A
trading range environment is likely until we get stronger internal breadth
numbers and higher quality and quantity of breakouts. 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

Bottom RS/EPS New Lows remained less than dominant with readings of 5, 7,
15, 10, and 11, with 4 breakdowns of 4+ week ranges, no valid trades and no
close calls. The short-side breadth has picked up some but is still below
optimum levels for aggressive shorting. If a further correction ensures, it
will be important to see if downside breadth picks up.

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.

Until
next week,

Mark Boucher

Here’s What’s Important In This Volatile Correction

BUY THE FEAR, SELL THE GREED

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