Improvement In Leadership Is Encouraging
The
market saw a notable improvement in leadership this week. The sectors
that are benefiting don’t typically start the charge into a new explosive
rally, which leads us to point our finger at the most obvious non-participants:
technology stocks.
For
now, we turn our focus to those areas in the market that ARE
showing strong relative strength for evidence that this is indeed the beginning
of a real recovery. Cyclicals, in particular, have rallied off the September
lows with a good deal of positive momentum. It would be encouraging to see the Morgan
Stanley Cyclical Index (CYC on Bloomberg) break out to new yearly
highs.
If
this is accompanied by a breakout in the Dow
Industrials through interim resistance around 10,300, we would feel
even more comfortable taking new positions in stocks breaking out on our New
Highs list. However, in the same spirit as Greenspan’s comments in his
testimony to Congress, we want to emphasize that the recovery will likely be
subdued. As we noted last week, the broader market still appears to need a
successful retest of the September lows to gain the support it needs for a
meaningful rally. There are simply too many extraneous factors, the foremost
being the War on Terrorism, that prevent us from being wildly bullish. At this
point, we’ll take what we can get.
Investors
should look beyond the US stock market for signs of leadership in the global
recovery scenario. Asia (x Japan) and Eastern Europe are the leading emerging
markets, with selective improvement in Latin America. Ideally, these and other
global markets will give us a broad plurality of messages that a recovery is at
hand. It will take much more than a shift in sentiment. Investors should be on
the lookout for breakouts in commodity prices, economically sensitive
currencies, and a breakdown in global bonds.
The
New Zealand dollar and Australian
dollar are leading economically sensitive currencies.
If they can breakout to the upside of their trading ranges, this would
support the global recovery scenario. Alternatively, downside breakouts would
suggest that we are not yet in the clear. Bonds
are range-bound as well. For a moment
this week, they looked poised to breakout to the upside through 105, but failed
to do so. IF they fall on good volume below 98, it
would confirm that a recovery is imminent.
A
breakout in economically sensitive commodities would suggest the same. Lumber
continues to work higher. Copper is trying
to follow in lumber’s footsteps, but does not seem to have the same volume
support it had as it cautiously approaches the 75 level again. Cotton
failed to breakout through the key 42.50 level last week, but it doesn’t seem
likely that cotton will fall below 30, which, if it happened, would suggest that
the recovery is a lot farther away than we hope.
Investors can watch broader commodity gauges, such as the CRB
Index (CRBFCOMP on Bloomberg) for constructive base-building, and
especially for breakouts.
Top
RS/EPS New Highs were quite impressive this week compared to what we have
seen this year. New highs numbered greater than 20 for five consecutive days
(43, 24, 41, 55, 55), with two days exceeding 50. This is the kind of
consistency that we seek out to confirm the recovery scenario. Breakouts still
leave something to be desired because a lot of the same names have been
reappearing, but the there were still 36 stocks that broke out of valid
cup-and-handles or flags of more than four weeks. Bottom
RS/EPS New Lows thinned out as the week progressed (21, 33, 13, 7, 3).
There were no playable breakdowns on our New Lows lists, especially
within the context of newfound leadership in new highs. If Bottom RS/EPS New
Lows reach the same extremes we saw in Top RS/EPS New Highs this week, we would
have to change our tone. But for now we’re happy with the handful of close
calls we had on the long side of the market, most only one step away from
meeting our criteria. One stock in the leading building sector, American
Woodmark
(
AMWD |
Quote |
Chart |
News |
PowerRating), was added to our model portfolio.
Our
overall allocation remains DEFENSIVE with 84% in
T-bills awaiting new opportunities. 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 about 1.47% for the year 2002.
It’s amazing what just one strong week in one strong stock can do to boost a
portfolio’s performance!
For
those not familiar with our long/short strategies, we suggest you review my 10-week
trading course on TradingMarkets.com, as well as in 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
an environment unclear directionally, we also 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.
Upside
breakouts meeting up-fuel criteria (and still open positions) so far this year
are: Ryland Group
(
RYL |
Quote |
Chart |
News |
PowerRating) @64.3 (89.5)
w/74 ops; and a new position in American Woodmark
(
AMWD |
Quote |
Chart |
News |
PowerRating) @65.485 (66.93) w/55.85 ops. Continue to watch our NH list and buy
flags or cup-and-handle breakouts in NH’s meeting our up-fuel criteria — but continue
to add just two per week and only in leading groups until we get breakouts in
the major indices.
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 10-week
trading course) breaking down out of a downward flag or down cup-and-handle
that is in a leading group to the downside.
Overall,
the improvement in leadership is encouraging, although we would like to see more
industry groups participating. Once investors can be confident that the economic
underpinnings of the global recovery have fallen into place, it will be safe to
become less defensive.