Look At These First Quarter Reversals
Last
year and it appears this year have witnessed first quarter reversals
of many overdone trends from the prior year. Last year the dollar, commodities,
and stocks all reversed course in the first quarter and underwent drawn-out
corrections. This quarter the dollar got especially overdone in bearish
sentiment and has reversed sharply in an upside correction, while stocks appear
to be following suit.
Investors should be heavily
defensive here. Aggressive traders should look to be fairly balanced
long/short, with longs in staples, health care, Ireland, European financials,
and high-yield energy plays and shorts in weak groups like tech, consumer
discretionary, financials, and brewers. The Naz and Q’s broke down today and
more downside is likely to follow. We also like short-term dollar longs and
Asian currencies over Europeans in the forex market.
A re-rating of risk seems to be
a dominant theme in the markets. The Fed is set to hike until it bites, so get
out of his way. Most traders hate playing defensive, but it’s the most
important skill in both football and trading. The Colts reminded us of that in
this weekend’s playoffs. While the press went wild over the phenomenal
offensive performance of the Colts against a weak defense the prior weekend, the
Pats reminded us of how a strong and aggressive defense can put even one of the
best offenses in football into a funk. Similarly a volatile and negative market
environment can take the best trading system and turn it into junk. So play
defensively and stick to paired trades or cash until a clearer environment
develops so you have a full deck of capital to exploit when opportunities are
better. Remember that the key to making money in the long-term is knowing when
opportunities are highly in your favor and have substantial potential versus the
risk — and when that is not the case get out and avoid risking precious
capital. A fourth distribution day warns of further risks on the downside in
this market and we should await good signals of a better breadth and upside
volume environment before beefing up allocation to any trades here via our
strategy.
^next^
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 47, 57, 92, and 77 with 32 breakouts of 4+ week ranges, no valid
trades  and close calls in DTPI and VLO. Breadth has now dropped below the 20
consistent number desired for a favorable investing environment for Top RS/EPS
new highs. This week, our bottom RS/EPS New Lows recorded readings of 11, 11, 5,
and 5 with 7 breakdowns of 4+ week ranges, no valid trades and one close call in
TNOX. Valid signals remain in place in MLI and BHP.Â
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.
The current correction may stall when the dollar stabilizes. The rally coming
off of that low will be critical to watch for investors to determine if another
leg up can transpire in the global bull move in place since late 2002.
Mark Boucher