I See A Good Chance Of A Further Rally, But Here’s What’s Needed
We now clearly have CONCERTED central bank
intervention and fiscal stimulus and it is quite possible that deflationary
pressures are at a turning point. Deflation in China is also being fought and
beaten. Is world deflation about to lose out to reflationary forces? Many
non-equity markets seem to be confirming this.
Junk yield spreads
are now narrowing consistently. Global bonds are showing signs of weakness and
are no longer making new highs. Commodity prices are rallying and staying
up. Commodity currencies are breaking out. A plurality of markets seem to be
suggesting that the global economy will turn around here soon and that
reflationary forces will emerge victorious — at least for the next quarter to
year. That SHOULD means more equity rally
ahead. However, WAR jitters can knock things around
on a moment’s notice. So risks are still pretty high. A breakdown in the dollar
would also not be helpful to US stocks.
This means investors
following our strategy are waiting with their fingers on the trigger for the
emergence of more evidence of breadth, follow-through and leadership before
increasing allocation to the long side with any significance. And therein lies
the rub, so far. The breadth and leadership of the rally since the 10/10 lows is
OK though not clearly strong. We have had two follow-through days, and one
breadth thrust during this rally. It would be very helpful to have more breadth
thrusts like another follow-through day up, a 9/1 up/down volume day, 5-day
moving average of advancing volume to be 77% or more of total volume, an 11-day
A/D ratio of 1.9 or more, or a 10-day A/D ratio of 2 or more.
The June rally also
showed ONE breadth thrust and so having two breadth
thrusts over the last six months IS the best
showing via breadth thrusts the market has displayed since the October 1998
lows. BUT, so far the rally has been mainly
concentrated in the weakest stocks of the prior bear move, and leadership is
just now BARELY beginning to show signs of
life. The stocks that have broken out have not had solid continuation, though
there are signs this is beginning to improve. If volume,
breadth, leadership, and follow-through can emerge, we suspect this rally
could develop into the strongest and longest bear-market rally we’ve seen since
the March 2000 peak. Let’s tip-toe into the long side here while continuing to
wait with substantial allocation for stronger evidence of leadership and follow
through.
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 38% 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 92% in T-bills awaiting new opportunities, with one sole long position.
Our model portfolio followed up weekly in this column was
up 41% in 1999, up 82% in 2000 and up 16.5% in 2001 — all on a worst drawdown of
around 12%. We’re now up around
7.01% for the year 2002.
Unbelievably
Top RS/EPS New Highs have still mustered up just ONE
solid week of consistent +20 or higher readings since the 7/24 lows. Readings
this week were 10, 10, 8, 7, and 14, accompanied by just 3 breakouts of 4+ week
consolidations within these new highs, with one close call on
Royal Gold
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PowerRating) (not
leading group). While follow-through is improving on recent close-calls, breadth
is back in the pathetic range. Let’s see if we can get 20+ breakouts
consistently, some follow-through on close-call breakouts, and some consistent
group leadership. Not there yet, darn it!
Bottom RS/EPS New Lows are stuck in the
no opportunity zone with readings of 0, 2, 1, 1, and 5, accompanied by 3
breakdowns and no close calls. Notice that our analysis of new low breakout
quality helped keep us from getting trapped on the overly bearish side of the
market in the decline from late August, and that we’ve missed some potential
traps on the upside so far in this deceptive rally.
For those not
familiar with our long/short strategies, we suggest you review my book
The Hedge Fund Edge, course “The Science of Trading,” and
new video seminar most of all, where I discuss many new techniques.
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
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PowerRating) @40.99 (42.76) w/
37.2 ops (raise the stop on a new high to recent flag correction lows). 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 (soon?).
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 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.
My best guess
remains that the market is heading for a “B†wave rally here and that the
deflation threat has TEMPORARILY been halted with
the global economy likely to improve soon. Eastern European markets and Asia
are leading the rally, and deserve attention (dominance) in global portfolios.
Commodities are starting to break out. Fiscal stimulus and monetary stimulus
are being deployed. IF the war
APPEARS to go well we could even get a rally
throughout MUCH of 2003 before excess capacity
problems reassert themselves and the effects of all this stimulus dry up and we
retreat again (or conversely inflation threats perk up faster than expected —
watch GOLD).
Yet
WE MUST LET THE MARKETS CONFIRM THAT THERE IS ENOUGH
STRENGTH TO SAFELY PARTICIPATE IN THIS RALLY. And that still requires
much stronger evidence of clear new group leadership, substantially more
breakouts of close-calls or stocks meeting our criteria, better and more
consistent follow-through by those close calls and criteria stocks that do
breakout, and substantially more breadth of new highs and breakouts on our
list. Watch and wait for opportunities to improve. Don’t forget that profits
can come VERY QUICKLY when things all line up
correctly — like the nearly 50% gain we took from the late ’99-early 2000 three
months. But patience is required to not give our big gains back in a less the
optimal period.
Until next week,
Mark