More Consolidation And Correction
As we noted last week,
last Tuesday’s highs in the Dow and S&P hit key Fibonacci time and price
levels at the same time, and the decline off of these significant resistance
levels has been stronger than we initially suspected. We’ve had a couple of
distribution days, and a couple more, combined with a break below the late April
lows by the S&P and Naz which will make this market quite worrisome.
Therefore, we’re at a somewhat critical behavior level here. A good strong rally
off of Wed.-Thurs. lows will allow a sigh of relief for the bulls. But a weak
rally off of this Fibonacci support zone and further downside on higher volume
for a couple more days will lead to a substantially different market environment
than we’ve had since the March bottom. The pre-earnings announcement season is
upon us and is so far wreaking a bit of havoc.
Many investors are puzzled by my hesitant
bullishness in the move since the March lows. After all, the liquidity cycle
could hardly be more bullish with five consecutive rate cuts in a row by the
Fed. And yes, five rate cuts led to higher markets and a decent longside
environment for stocks in 1971, 1975, 1982, 1986 and in 1989 — but let’s not
forget either that five fast rate cuts, even eight fast rate cuts, did nothing
for the market in the 1930-31 period. I certainly don’t believe in fighting the
Fed, but I also don’t believe that the Fed is God. We’ve had a huge bubble in
high-tech that has been popped. Japan cut rates more than 10 times following its
bubble being popped, but it hasn’t led to a decent bull move of any significant
duration for over a decade. And breadth has been decent on this rally, but not
normally as strong as at any significant bull market bottom yet — either on our
own Top RS/EPS lists or on any new-high/new-low lists. And the nagging economic
question remains whether Fed rate cuts can quickly turn around an economy where
significant sectors show excess capacity problems — and whether such a
turnaround can cause even a normal rate of earnings increases. Time will tell —
and so will market breadth action. But until we either get clearer evidence that
the Fed’s rate cuts have teeth, or that the breadth of the market is becoming
more normally road, I’m likely to remain a bit cautious in here, and I suspect
that our model will as well.
A look at economically sensitive commodities is
starting to be a bit more troubling now than in recent weeks as well. Cotton has
crashed to new lows and looks set to continue its runaway down move in to the
30s. Bonds look to be forming an intermediate-term bottom with today’s sharp
rally off of a Fibonacci price and time point and double bottom potentially
forming. Lumber, which exploded off of the double bottom we commented about in
March, is now in a freefall and significant retracement of its parabolic rise.
Copper is on the verge of new lows, signaling that a fast economic rebound is
not very likely. And gold, along with some of the leadership of this bull move,
resource stocks (with the exception of oils) are also retreating a bit more
strongly than would be optimum for a maximum bullish case.
Let’s
look at some numbers from the week. New
Highs vs. New Lows on our RS/EPS lists were
15/1, 17/1, 19/6 and 17/11 — this week new highs fell consistently below 20 and
new lows even began to expand. Oh, for the days of new highs on our lists above
50 daily and above 100 a time or two each week again. The market is acting like
a bullish-bias trading range so far, not a launch to a new multi-year bull
market. New lows picked up a bit as did breakdowns this week — but we are far
from a decent short-sale environment either. There were eight breakouts on the
upside to new highs of stocks on our Top RS/EPS New Highs lists with really no
close calls (FRX was the closest, but had not even close to decent volume on its
breakout), with only three breakdowns on the downside of four-week-plus
consolidations on our Bottom RS/EPS New Lows lists, but with a short-sale trade
in DT and another close call in USG (bad group and PE too low). Close calls are
stocks almost meeting our criteria that broke out of sound bases. The
environment thus remains not yet nearly optimum on the longside or the shortside.
Our
overall allocation is still relatively DEFENSIVE with 8% short and 32% long and the
remaining 60% 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 6.35%, with a mostly cash position, though the last few weeks,
where we’ve actually had some exposure, has given us some slight gains in our
portfolio for the year.
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” and course “The Science of Trading.“Â
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. 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.Upside
breakouts meeting up-fuel criteria (and still open positions) so far this year
are: Atlas Pipeline
(
APL |
Quote |
Chart |
News |
PowerRating) @28 (48.6) w/42 ops; and International Game Tech
(
IGT |
Quote |
Chart |
News |
PowerRating) @57.95
(59.52) w/55 ops; and TRC
(
TRR |
Quote |
Chart |
News |
PowerRating) @36.32 (42.28) w/45.5
ops. We now have profits locked in on two out of three positions, and a
very small potential loss in our third position.
Continue to
watch our NH list and buy flags or cup-and-handle breakouts in NH’s meeting our
up-fuel criteria — but continue to add just two per week and only in leading
groups.
On
the downside, 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: DeutcheTelekom AG
(
DT |
Quote |
Chart |
News |
PowerRating) (20.3) w/23.5 ops.
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. Here
too, remain cautious by only adding two shorts in a week, until we get
more consistency in the number of downside breakouts in a given week off of our
Bottom RS/EPS New Lows lists.
I know I’ve said this again and again, but if
this is a REAL bull
market, breadth will improve, new highs meeting fuel criteria will broaden, and
we’ll get the opportunity to raise our allocation to the market. If this is
not a real bull market, we’ll get a situation like we had last year from March
through September — where we make some money with some allocation to longs, but
the bull never really takes off, and we are able to lock in profits without
getting faked out. Remember that our goal is to make safe, low-risk, reliable
profits consistently, not to buy bottoms or short tops. so we’ll continue to
wait for a clearer environment from a breadth basis before pouncing on
opportunities. Right now opportunities exist, but they are not abundant. There
is some ripe fruit on the tree, but if we wait for the ripe fruit to be falling
off the tree, it will be a better time to load up our basket. And loading up
your basket with fruit that isn’t ripe yet, and then eating that fruit, can make
you sick to your stomach. Patience! Pouncing on reliable opportunities when they
develop with abundance before committing much capital is key.