My Top 10 Themes For 2004

Looking on a top-down macro basis,
the major theme of 1982-1999 was disinflation and the revaluation of global
equities. The main theme of 2002-2002 was adeflation scare and a popping of
the bubble in equities created by this secular move and too loose monetary policy.
In 2003, the main theme was REFLATION and the successful turnaround of global
economies from the brink of global deflation.

For 2004 and 2005, a transition from REFLATION to INFLATION
appears likely. The bulk of monetary and fiscal policy stimulus has had its
impact on financial markets in 2003, with the desired effect. Global growth
is turning around. We expect this trend to continue, absent major shocks like
a large terrorist event, a major earthquake, an oil shock, or global war. But
earnings and corporate profitability, along with employment growth, will have
to take over the burden of producing gains in global stock markets in 2004.

While we still expect the global economy to surprise on the
upside, earnings growth has probably already peaked. We look toward US earnings
growth of around 12%. With valuations still at the high end of normal, this
means a long-only stock approach is not likely to prove nearly as profitable
in 2004 as it was in 2003. Gains of 8%-15% may be possible, but it is likely
to be a much rockier road, and the distinct possibility exists of tops being
made in 2004 or 2005 once inflationary pressures become more obvious.

We suspect strongly that investors will have to be much more
flexible and opportunistic in their investing approach in 2004 than in 2003,
to produce decent gains. Sector rotation will be key, as will be risk reduction.

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Major themes that we believe investors should emphasize UNTIL
POLICY MUST CLEARLY TIGHTEN, appear as follows:

1. REFLATION —
a debt collapse is not likely, absent a shock, at least until it is clear that
policy must tighten. At that point, watch closely for potential derivative disasters
surfacing and for how sensitive markets are to tightening. It is not yet clear
whether some benign tightening can develop or whether markets will move sharply
lower immediately upon sensing that tightening is inevitable. Our bias is that
this cycle will be slow to catch and that markets will be able to absorb tightening,
initially.

2. Housing remains strong.
Until and unless markets strongly react to initial tightening, we suspect that
housing will hold up much better than most investors are anticipating. There
is very little indication of a housing bubble despite popular media representations
of such. Housing has not had the runup in price to historically stretched valuations
that is a common characteristic of every bubble in history.

3.Investors
should watch “canaries
in the coal mine”
to determine that
the reflation theme is being unwound. Risks include: continued falling
money growth, widening credit spreads, bank failures, plummeting bank shares,
evidence of capital flight, a bond market collapse, a dollar collapse, and sharply
lower global stock prices.

4. Our favorite developed countries
are:
Japan (particularly small cap), Spain,
and Germany. The
EU is surviving a higher currency much more benignly
than many have thought possible because global demand growth is out-powering
the negative impact on the Euro. EU countries will not experience market share
growth, but will still experience rising export demand.

5. Our favorite Emerging Market
countries are:
China,
Latin America, Russia, India, Asian commodity exporters.

6. Emerging markets still have
better value and better growth prospects than the developed markets

and look likely to outperform for as long as the upcycle continues. Beware though,
because they will underperform on the downside as well.

7. Early 2004 is likely to see
late cyclical outperformance
. Favored themes are base metals,
materials, industrials, resources, energy, natural gas, gold.

8. Small-cap value is still our
favorite segment of the markets globally
— but use funds
or iShares so you can get out of this thin segment quickly. While small cap
outperformance should slow as all of the valuation gap has been closed, outperformance
should continue in the growing growth environment ahead.

9. The dollar should continue
soft
in 2004, though it could experience a sharp rally at any
time.

10. The commodity currencies should
lead,
just as they did in 2003, but the euro will have to correct
for the Asian currencies’ lack of adjustment. The lagging commodity currencies
should shine in 2004, like the CLP, ARS, RUB, and IDR. China and Asia will not
effectively revalue substantially until inflation becomes a problem for China
— and this is not likely until mid 2004 to 2005 at the earliest, and perhaps
much later. Watch Chinese inflation gauges like a hawk.

image src=”https://tradingmarkets.com/media/2004/Boucher/mb010904-07.gif” />

We will update investors as our list of top themes changes,
but investors need to stay closely aligned to rapid shifts in 2004 much more
than in 2003. We wish all investors a very prosperous year in 2004.

^NEXT^

Our US long/short model is doing reasonable well considering the low level of
allocation it has had. We have long encouraged investors to supplement this
strategy with or favorite foreign and global asset plays. Investors should continue
to cautiously add stock exposure as trade signals are generated that meet our
strict criteria, as well as allocate to our favorite segments. 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 this year.

image src=”https://tradingmarkets.com/media/2004/Boucher/mb010904-01.gif” />

This week in our Top RS/EPS New Highs list published on TradingMarkets.com,
we had readings of 51, 91, 82, and 62, accompanied by 29 breakouts of 4+ week
ranges, with no valid trades and close calls in
(
PTNR |
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and
(
GALN |
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.
Internal strength has come back SOME, but still remains slightly suspicious.
Position in valid 4 week trading range breakouts on stocks meeting our criteria
or in close calls that are in clearly leading industries, in a diversified fashion.
This week, our bottom RS/EPS New Lows remained non-existent with readings of
0, 2, 1, and 0, with no breakdowns of 4+ week ranges, no valid trades and no
close calls.

For those not familiar with our long/short strategies, we suggest
you review my 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 change in the
new-economy/old-economy theme appeared to be upon us. We’ve been effectively
defensive ever since.

On the long side, we like the close calls from this week,
(
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and
(
GALN |
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,
the two valid trades from past weeks,
(
PETD |
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and
(
RADN |
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, and recent
close calls from past weeks,
(
JCC |
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,
(
NIHD |
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,
(
FDRY |
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, and
(
FCX |
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,
as well as in our favorite global sectors. On the short side, we like the close
call from several weeks ago,
(
TRMS |
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PowerRating)
. We also like broad metal stocks, like
FCX, small-cap Emerging Markets in general, metals and resources, India, broad
Latin America, Russia, and broad Asia. But use tight stops in all of these plays
as the upside party is well established and a bit overdone.

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Mark Boucher