Investors: Be Nearly Sidelined. Traders: Be Fully Hedged

• April 15, 2005
• Mark Boucher

Critical
Level Test

 

Editor’s Note:

Mark wrote this commentary on Thursday.

Brice

 

The Nasdaq is leading the
market lower, having already broken below its 200 and 50 day MAs as well as the
support from 2005’s lows.  A break below 885 further establishes a downtrend
here.  But the other broader major indexes are testing critical support levels
both at the 200-day MA and at the January lows.  A break below 115 on SPY and
102 on DIA on high volume would turn this market decidedly bearish on an
intermediate-term basis — and should be used as an all-out defensive signal to
investors with any outright long exposure left.

 

 

Last week we commented on
health care’s rise to ascendancy.  This week Pharmaceuticals broke out (PPH),
further confirming that the weakest member of health care is moving up too.  We
like PPH over SPY or over weak groups, but would avoid outright longs without
corresponding shorts in this environment.

 

 

Despite Fed backtracking on
some of its most hawkish rhetoric, and despite a nice volume reversal in the
middle of the week, the market is looking more and more like it will have to
correct in response to this biting phase of Fed hiking — a move by the major
indexes below the critical levels above will confirm this and an
intermediate-term bearish tone.

 

 

Investors should be nearly
fully sidelined, while traders should be fully hedged with shorts against
longs.  The best long-side groups appear to be Aerospace and Defense, Soaps and
some staples, health care (a broadening range of groups here and our favorite),
telecom, and non-cyclicals;  while the best short-side groups appear to be auto
equipment, financials (S&Ls and mortgage services especially), home retail,
electronics and computer retail, RV building, and home appliances.

 

The dollar rally we’ve talked
about for months, seems to be continuing, and with this and the less supportive
action in bonds, commodities are taking a hit as well.  We believe this is a
correction in a secular bull market for commodities and gold, but it appears to
have clearly arrived.

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. 

This week in our Top RS/EPS New Highs list published on TradingMarkets.com, we
had readings of 64, 35, 27, 35, and 35 with 21 breakouts of 4+ week ranges, no
valid trades and no close calls.  This week, our bottom RS/EPS New Lows recorded
readings of 13, 21, 24, 35, and 18 with 14 breakdowns of 4+ week ranges, no
valid trades and close calls in NDN and OTL.  Valid signals remain in place in
LCAV and CHTT on the long side and ALO and BOBE on the short-side.    Notice
that neither new highs or new lows are exceptionally strong this week. 

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.

A big part of keeping risk down and profiting consistently in the markets is
knowing when not to risk capital much.  Only investing substantially when the
odds are substantially in your favor is critical.  There are some relative value
themes that investors and aggressive traders could exploit here, but most
investors should be mostly out of the market and awaiting better odds
opportunities here.

Mark Boucher