Let’s Call It A Trading Range Until Breadth And Leadership Appear

It
is clear that whatever guerrilla forces attacked the World Trade Center and
Pentagon, and whatever guerrilla cells are sending anthrax, they are attacking
the media and the Eastern Establishment and creating “war fever” by
those in power. A real question investors
must watch for will be indicated by future terrorist/guerrilla attacks — Are
they merely trying to pull the U.S. into a protracted war in Central Asia, or do
they want to try to instigate a world war with Muslims against the Western
Alliance? 

So
far the attacks have been mostly against the U.S. and Israel. If targets
continue to be mostly in the U.S. and Israel, then it will look like the
intelligence behind the attacks wants a Vietnam in Afghanistan and Iraq, in
addition to Palestinian dominance. But if
there are more attacks against Europe, like the chemical plant explosion and anthrax
packages in France, and more eruptions in new regions, like escalation of
fighting between India and Pakistan, then we should begin to look for a pattern
of actions designed to pull the peaceful Muslims toward joining forces in a
global war against the West.

It
is clear that the Sept. 11 attack was an extraordinary military operation.
Investors and forward-thinkers should watch carefully and try and
understand what this astonishing move was the prelude for and what the ultimate
aim of this group is. It is unlikely that
such a brilliantly planned operation was conceived merely to inflict random
damage, and without a real goal or aim. Let’s
not underestimate our enemies, but try to understand them, because right now
their actions are impacting markets enormously.

A
land invasion would likely be met with an initial rally — but pending news, it
will be a tough one to play. Lack of a
land invasion or a turnover of bin Laden over the next few weeks will likely be
negative for the markets — because it will mean that a land invasion will not
be possible in the Afghan winter until at least February, and that the
terrorist/guerrillas can continue to inflict damage on us until winter ends.

So
far we have neither the breadth indications nor leadership indications that a
sustained up-trend is in the making. The
market DID reach historically oversold levels, and we have had a minimally
expected bounce off of those deeply oversold levels.
But the markets are EXTREMELY RISKY because they are reacting to news
with violent volatility. With this much
uncertainty in the market, sentiment can change from bullish to bearish on a
dime — on any shift in news. That’s why
we continue to advocate caution.

Unfortunately,
economically sensitive commodities remain clearly and universally bearish.
Commodities are thus still clearly discounting recession with no recovery
yet in sight.
Most economists and econometric models have extended the arrival of a
recovery to the second quarter of 2002 or later.
Earnings are likely to be quite negative in the weeks ahead, but the
shift in sentiment from news is likely to be the biggest factor in shaping
markets this quarter.

Let’s
look at the breadth numbers on our lists for the week.
Top
RS/EPS New Highs vs. Bottom
RS/EPS New Lows for the latest week were 23/2, 7/6, 13/6, 19/5 and 14/9.
Breadth is trading-range indicative — with no clear dominance by shorts
or longs and neither showing 20 or higher consistently on the week.
Breakouts vs. breakdowns of four-plus-week consolidations on our lists
for the week were 2/1, 1/0, 1/1, 2/0 and 1/3. No
close calls on either side, make this mixed bag a grinder.
Breakout numbers are not even close to what we would expect on a daily
basis on the upside if this rally is to develop the leadership typical of a
sustainable up-move. Developing many
breakouts of nearly up-fuel criteria stocks is the most important component of
determining whether this rally is playable or not. 

Our
overall allocation is now SUPER DEFENSIVE with 100% in T-bills awaiting new
opportunities. Our
model portfolio followed up weekly in this column ended 2000 with about an 82%
gain on a 12% maximum drawdown, following a gain of around 41% the prior
year. For year 2001, we are now up
about 12.6%, with a heavy cash position. 

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 on
leading or lagging industries according to our group and sub-group new high and
new 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.