How The Disciplined Trader Prepares For Uncertainty
As we
have suggested for months, geopolitical uncertainties are weighing on
the markets and keeping buyers and sellers on the sidelines.
The next few days could prove critical in terms of helping to set the
timeline for a probable US attack on Iraq.
I have long favored a military
embargo of Iraq, short of all-out attack and war, that could succeed in better
containing Iraq and preventing it from exporting oil illegally through Syria in
violation of UN sanctions. The great fear
that Iraq will continue to put WMDs in terrorist hands while training,
financing, and providing intelligence to terrorist cells is real enough that
those who argue the UN is not strong enough to prevent an onslaught of terrorism
have a point. A military embargo could
also prevent Iraq from taking delivery of the alleged Nuclear weapon it has
allegedly purchased from North Korea, which would provide a nuclear shield and
umbrella for its terrorist-linked activities.
Yet those who advocate peace
are failing to come up with more realistic alternatives to war that address the
hawks’ concerns, as an embargo might. And
so time is now growing possibly too short to prevent war.
President Bush scheduled a speech for Thursday night, in which many
predicted he would set the timetable to war via a final ultimatum to Saddam. Therefore investors must
prepare their portfolios for war and massive volatility and uncertainty.
The time of uncertainty over when the war will start may soon be closing,
but it will likely give way to the time of uncertainty about the implications
and results of that war, which will change with each day’s news, and may be
even more difficult to navigate than the last many weeks have been.
The markets are coiled to move
sharply in either direction, depending on whether the war is quickly successful
or not. Remember too, that even
short-term apparent success in Iraq which would lead to sharp rallies in stocks,
could be reversed on a dime upon any terrorist revenge acts or negative events
in other locations. Iraq is not the end
of the War on Terrorism that will be ongoing. An
unclear outcome after just a few weeks will likely send stocks and the dollar
down and oil up further into the stratosphere, leading to a much more likely
reversion to global recession. Will our
attempts to install democracy in Iraq be any more successful than they have been
in Afghanistan? The stakes are huge
here.
Blix will again report to the
UN on Friday, but this may be immaterial to the war, which is probably why
Bush’s speech occurs before Blix’s report.
I don’t suggest trying to
play the war financially, because even experts do not have strong indications of
what may happen. Those who must hedge
because they cannot liquidate major positions that would be affected by war
should consider some hedging via crude puts in the event of a positive war
outcome, and to hedge a negative war outcome via leap puts on oil sensitive,
consumer sentiment sensitive, and bellwether stocks as well as calls on global
short-rates. The cost of this insurance
is high and growing though, and high levels of cash are preferred.
Therefore investors should keep
a mix of cash in various currencies (Everbank.com) and sit on their hands mostly
until the global showdown develops some clarity.
Once war-jitters recede and the
outlook is less risk-prone, we believe the market will launch a strong and more
sustained move — though we don’t yet know in which direction.
Watch and wait for volume, breadth, leadership, and follow-through to
emerge in one direction before
allocating serious capital to either the short or long side.
Caution is still advised strongly.
Since
March 2000 the world index is down over 45%, the S&P over 48%, the IBD mutual
fund index is down over 62%, and the Nasdaq has crashed over 76%.
Meanwhile since March 2000, the long/short strategy we summarize and
follow-up each week in this column has made more than 39% on a worst drawdown of
under 6%. While this
performance is certainly underperforming our long-term growth rate, 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.
Our official model portfolio
overall allocation remains VERY DEFENSIVE.
We’re now 84% in T-bills awaiting new opportunities, with two sole long
positions. 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 0.81% for the year 2003.
To our daily Top
RS/EPS New Highs list the entire rally from the 7/24 and then October lows
never even registered on the radar screen having mustered up just ONE solid week
of consistent +20 or higher readings since 7/24.
We had readings of 12, 24, 18, 9, and 7 new highs last week in our Top
RS/EPS New Highs list, accompanied by nine breakouts of a 4+ week range and a
few close calls (such as Blount
(
BLTI |
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Chart |
News |
PowerRating),
STET Hellas Telecommunications
(
STHLY |
Quote |
Chart |
News |
PowerRating), and
Cimarex
(
XEC |
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PowerRating)).
Bottom RS/EPS New Lows last week showed readings of 19, 12, 13, 35, and
55, but were accompanied by just seven breakdowns of 4+ week patterns without
any clear close call on the short side. The
bottom line is that highly reliable low-risk opportunities remain scarce in this
uncertain environment.
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 US 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 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 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: Port
Financial
(
PORT |
Quote |
Chart |
News |
PowerRating) @40.99 (49.1)- w/
a 44.5 ops to lock in profits, and WebMD
(
HLTH |
Quote |
Chart |
News |
PowerRating) @9.44 (9.75) w/ an 8.5 ops. Continue
to watch our NH list and buy flags or cup-and-handle breakouts in NH’s meeting
our up-fuel criteria — but be sure to only add names that are in leading
groups, and now only add two trades per week once again until leadership and
follow-through improve.
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) in: 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.
There’s a lot of speculation
about how to “clean-up†on the results of the war in the financial markets.
But disciplined traders are always simply looking for low risk ways of
exploiting a highly reliable trend via strategies that stand the test of time.
Uncertainty is something to run from (to cash).
Better and more reliable opportunities will develop in the markets later
this year when geopolitical uncertainties are less burdensome.
There may be opportunities from the war, but they are difficult to fit
into low-risk reliable situations. I
advise most investors to wait on the sidelines for a better environment.
Mark Boucher