In 2005, Here’s What To Watch
Decent Global Equity
Environment Extending Into New Year
The typical seasonal year-end
rally has developed on par. Many would have us believe that simply because the
year 2005 ends in a 5 that it will be a big up-year just as nearly all the 5’s
in the last century have been. Unfortunately it is unlikely to be so easy. The
last many 5’s had substantially different liquidity and valuation situations
going into them, and we suspect the later is more important to the upcoming
year’s equity environment than the mere fact that the year is a 5.Â
What we do know is what the
market is doing and where leadership is coming from. Latin equities in general
and Brazil in particular continue to lead to new highs. So do transports,
railroads, and managed care. Growth Europe such as Hungary, Austria, Belgium,
and Ireland are also leading on the upside. Even some slower Europe with good
value such as France are breaking out here. South Africa continues to march to
new highs as well. New leadership seems to be developing in more defensive
sectors such as consumer non-cyclicals, health care, and biotech. The Dow seems
to be outperforming the Naz, and some technology groups look relatively week.Â
Defense stocks have broken down this week in worrying fashion as well.  Oil
stocks continue to hold up well. Investors should stick heavily with the
leaders and watch for potential further evidence of rotation into defensive
groups and large-cap/small cap in 2005. We suspect from this internal activity
that it will be a much more volatile and tough year than the 5 theory suggests.Â
In particular we suggest
investors watch bonds very carefully in the year ahead. As long as bond prices
to do not fall materially the recovery and mildly positive global equity market
environment are likely to continue. Yet as soon as bonds turn down
significantly, the punchbowl could be removed from the party much quicker than
anyone imagines.  The Fed is still raising rates and nobody, not even the Fed
who admits as much, knows when rate-hikes will start to bite. We suspect that
rates above 3% will hit the markets harder than most observers anticipate.Â
Investors may want to go back into this columns archives and review our
discussions of the Asia-US virtuous circle. We don’t yet know when or how this
will derail, but it is unsustainable and eventually the piper will have to be
paid.  We suspect that 2005 may still escape full wrath of reality, but
investors must understand the unstable foundations upon which this bull move and
recovery are built. There may be years of further reflation before inflation
becomes a problem here or in Asia, or until the drain from the massive current
account deficit is too much and consumers slow spending and the world slips into
recession and deflation. Investors need to understand this potential dynamic
and keep one finger on the trigger to exit market positions during 2005.Â
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.Â
This week in our Top RS/EPS New Highs list published on TradingMarkets.com, we
had readings of 104, 98, 139, and 111 with 34 breakouts of 4+ week ranges, no
valid trades  and close calls in XXIA and LCBM. Breadth is expanding again and
more close calls would be a call to add some long exposure. 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.Â
This week, our bottom RS/EPS New Lows recorded readings of 3, 5, 22, and 4 with
no breakdowns of a 4+ week ranges, no valid trades and no close calls. We’re
seeing a growing number of valid breakouts, though this is not a gung-ho
environment. Valid signals are in place in MLI, KMRT, GBX, and BHP. The rally
is still in place but starting to thin in breadth here, so investors should
remain aware of possible headwinds looming as discussed over the last few weeks.
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.
2004 has been a volatile and tricky year for investors. We suspect 2005 will be
similar — with the need for defense and nimbleness being critical to investors
success. Yet for now the bull rocks on and gives us a good holiday. Happy New
Year to all — and a very prosperous 2005 to come!!
Mark Boucher