Looks for signs of leadership

Last week we suggested that investors watch our list of Top RS New Highs closely
for breadth improvement and for a broad number of stocks meeting these rigid
criteria breaking out to the upside and assuming leadership roles as a way of
telling one whether this rally is playable or not.

This week, let us also suggest that investors should monitor the stragglers of
the rally and leaders of the down-leg to monitor whether any of these segments
and sectors are dropping-out of the rally and returning to the downside. Should
that begin to happen with a broader range of downside leaders, it would likely
mean trouble for the durability of the current rally, and if it grows
substantially, that a new leg down is commencing.

Some of the leaders on the downside included US Housing sector, General
Merchandise, health care equipment, QQQQ’s, Middle Eastern, 2nd Tier Eastern
European, Turkish, Indian, Korean, and South African indexes. Currencies in
Turkey, Iceland, India, and Hungary, as well as commodity currencies also led
the down leg. Dubai and Slovakia led the decline and are already now making new
lows. So far much of the Middle East is still holding up, but Lithuania, Latvia,
Estonia, Jordan, Kuwait, Egypt, Turkey, Korea, South Africa, Greece, and Qatar
are only rallying feebly so far. Leading sectors housing, health care equipment,
the QQQQ’s, and General Merchandise are also rallying feebly and should be
watched for new lows. The commodity currencies continue underperformance, and
though the Turkish Lira, Icelandic Krona, Indian Rupee, and Hungarian Forint
have all backed off of their lows, they are beginning to weaken again. Watch
these dropouts for negative action. New lows by currencies, stock indexes and
groups that led the rally in increasing plurality will be a potential warning
sign that the forces of decline are starting to take hold again.

The leaders and laggards should tell the tale and tip their hat toward the next
catch able move. Investors and traders should watch carefully. As long as there
remains little plurality of leadership on the upside and little plurality of
leadership on the downside, our bias is growing toward expecting a
roller-coaster environment that has trouble following through in either
direction for a durable move.

Particularly with the Fed and other central banks so data driven for their next
policy moves, remember that one report that shows inflation pressure continuing
could pull the rug out from under the current market rally, whereas evidence of
substantial weakening in growth enough to cause bonds to rally could undercut
any market decline. We suspect that until growth slows the environment will be
tricky.

In late March we began writing about the danger of the current market
environment and how in 2006 the macro big picture would likely SWAMP all trading
strategies and that not understanding the precarious position the world was in
would be a detriment to traders. We hope you listened. In addition I have
written the “2006 Investment Roadmap” and now the new “Mid-Year Update 2006
Investment Roadmap” (see below) precisely to analyze and explain why this
happened, how it was anticipated, and what it means for the future as well as
what to watch to determine how this GLOBAL TINDERBOX will blow. I still honestly
believe that the ramifications to investments of events over the period directly
ahead will be as substantial as any period in post WWII history. I honestly
wouldn’t want to trade in any timeframe without a full understanding of the
current dangerous macro environment and how the recent decline could be just the
tip of the iceberg IF certain developments transpire from here. You’ve been
warned and warned again.

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.

Our US selection methods, our Top RS/EPS New Highs list published on
TradingMarkets.com, had readings of 58, 83, 40 and 39 with 28 breakouts of 4+
week ranges; no valid trades meeting criteria, and no close call. This week, our
bottom RS/EPS New Lows recorded readings of 14, 16, 18 and 24 with 1 breakdowns
of 4+ week ranges, no valid trades and no close calls. The “model” portfolio of
trades meeting criteria has some time back exited all positions and is 100% in
cash.

Our advice continues to be defensive and sidelined positions with the bulk of
assets until technical breakouts and strong breadth seem to align with a macro
scenario that makes sense for a sustainable global rally, or until a clear
plurality of downside leadership breaking to new lows in the laggards develops
for plays on a negative trend.