Indexes May Have Made A Turning Point This Week

On the other hand, if bonds
break above this week’s lows and all three indexes break below this week’s lows,
then that will be a significant failure that will likely signal a full-fledged
test of the September lows for the indexes — such a full-fledged test will
likely begin to drag down even the leaders of this rally to date with it
temporarily. 

This global rally continues to
be led by EM Asia (x-Japan), EM Eastern Europe, EM Latin America, U.S. and
global small cap value, and resource-oriented stocks.
These are the groups to participate in and to watch — and so far this
correction in indexes has not so much as touched a hair on their head. It would not surprise
me to see the weakest segments of the market, high-tech and communications
stocks that are still wildly overvalued, to fall to new lows while the
leadership continues to march ahead. All
the Fed’s rate cutting did indeed prevent a worse route from plunging the
economy into a prolonged recession, but at the expense of preserving
overvaluation, which must now be worked off over time. 

Investors should also continue
to watch the commodity markets. The
Goldman Sachs index and the CRB both dropped sharply to their long-term MA
support levels and have since bounced a bit. Lumber
has undergone a serious correction that bears watching closely, particularly if cotton
and copper follow suit, and bonds
break above this week’s highs. Economically
sensitive currencies though continue making new highs, and any decline in
commodities should be accompanied by sharp declines by the AUD
and NZD to be definitive.
But all investors should be watching these markets closely for clues as
to whether the global recovery will continue or abort.

Looking
at the broad plurality of markets and following their message is more
constructive than getting wrapped up in predictions, and right now they are in
agreement on the global recovery scenario. Commodity prices broke out a couple
of months ago, commodity-sensitive currency prices followed, Latin EMs gained in
relative strength, commodity-sensitive stocks gained relative strength, and
about 100 economic gauges began picking up real steam. Since then, almost all of
them have rallied further, though some of them have corrected deeply.
The thing to watch for now is whether the breakout will lead to
follow-through or not. USUALLY
such a plurality of markets all signaling the same thing leads to a catchable
move, but not always. That’s where the
odds lie. But if the plurality of these
markets turns around to the downside, then it’s time to run for the exits and
adopt a more deflationary bias quickly.

There are weights on the market
that may make this a move that grinds higher rather than takes off.
Investors can expect to see more difficult-to-trade ranges and lackluster
activity in the broader market averages. Hunt for undervaluation and avoid
overvaluation. Keep looking for an
improvement in breadth, such as:

• a 9:1 up/down volume day
  (exceeded 6:1 this week but not quite there yet)

• the 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.

A true secular bull market will
give these kinds of breadth indications — though this move may not.
We’ve had a real scarcity of strong growth stocks at good value
breaking out that meet our criteria so far, thus our small allocation.
Nonetheless, our overall portfolio is marching ahead on the few good
stocks we have been able to participate in. Continue
to keep your powder dry until true opportunities meeting all of our criteria
appear.

Top
RS/EPS New Highs exceeded 35 every day
this week, increasing slowly but surely. There
were even fewer breakouts to choose from compared to last week, but the quality
of those breakouts was a little better. The
volume is coming on strong in new highs and there has been decent follow-through
in a lot of names like our position in America’s Car-Mart
(
CRMT |
Quote |
Chart |
News |
PowerRating). Bottom
RS/EPS New Lows were very hard to come by this week, still confirming the
global recovery scenario and leaving our model portfolio without any short
exposure.

Our overall allocation remains
DEFENSIVE, with around 70% 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 over 7.2% for the year 2002, mainly driven by a select couple of names which
is often the case in a market that is searching for leadership. Due to the
volatile nature of the U.S. market, we will probably see more frequent and
larger drawdowns than we’ve had so far.

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 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 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: America’s
Car-Mart
(
CRMT |
Quote |
Chart |
News |
PowerRating) @8.60 (14.05) w/12.25 ops; Garan
(
GAN |
Quote |
Chart |
News |
PowerRating) @45.60 (60)
w/53.25 ops; and Lands End
(
LE |
Quote |
Chart |
News |
PowerRating) @52 (49.93) w/42.50 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.

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 a plurality of markets
is still confirming the global recovery scenario, and the big picture will
remain healthy as long as Emerging Markets and small-cap value show leadership.