Nail-Biting On Retest Continues

July 12, 2002
Mark Boucher

The S&P flirted with the critical
924-950 support level weâ€™ve been speaking about for months. A clear,
high-volume, weak close below these levels will put a monthly chart Head and
Shoulders Top in place that would be pretty ominous from a longer-term
perspective. The dollar also continues to flirt with its lows, especially against the
European currencies. European economic growth has shown signs of turning down
recently and further dollar weakness will only make matters worse. Yet the EMs
and commodity markets stubbornly refuse to turn down in earnest and give a clear
signal that economic re-weakening is becoming a clear and dominant theme.

Global bonds appear to be discounting some less robust
growth, but are nowhere near the low yields of 1998. They are, therefore, not
yet tilting their hats toward deflation/recession returning globally
either. Thus we suggest investors continue to watch for a broadening of new
highs or new lows and trade cautiously, while looking closely at commodity and
bond markets globally to try and discern whether a new leg down in developed
market equities will take EMs with it again, and whether it will be enough to
abort the global manufacturing recovery that is currently under way. Right now
the markets are not painting a clear picture.

Breadth indications over the latest week are also not
dominant in either direction. We did have a strong breadth upmove the day
following the Fourth of July, but unfortunately it occurred on extremely sub-par
volume, making its validity quite questionable. Therefore we continue to advise
investors to be keeping an eye out for a 9:1 up/down volume day, the 5-day
moving average of advancing volume to be 77% or more of total volume, an 11-day
A/D ratio of 1.9 or more, or a 10-day A/D ratio of 2 or more to make for a
totally confirmed bull move. But again, donâ€™t be surprised to see a couple
follow-through days and no further breadth confirmation, leading to a small but
barely catchable upmove similar to what we had off of the September lows.

Our U.S. long/short strategy continues to show reasonable
gains with very low risk this year. Weâ€™re making money at a 15%-20% annual rate
so far this year, OK, but not exactly wonderful. Investors may have to adjust
to a lengthy period of global multiple convergence, where overvalued U.S. stocks
have trouble rallying en masse for many years, while certain sectors present
limited but good opportunities such as weâ€™ve seen in the homebuilding and
regional banking industries this year.

Top RS/EPS New Highs this past week weakened further with readings of 4,
13, 14, and 7, with no real close calls. Wait now for at least a couple
follow-through days before anticipating that this retest is over, and look for
solid leadership in the breakouts before thinking about getting aggressive on
the long side.

Bottom RS/EPS New Lows eased back last week to under 20 consistently with
readings of 5, 11, 43, and 90. Some days show strong breadth, but it is not
very consistent.

And the quality of new lows is still not indicative of a
solidly emerging trend move. There were only 10 breakdowns and three breakouts from
our new low and new high lists this week. Nonetheless, continued improvement in
new low numbers and quality will help tell us whether this is a retest of the
Sept. lows or whether it is the beginning of a new leg down in an on-going bear
market. Watch carefully!

Our official model portfolio overall allocation remains
VERY DEFENSIVE. Weâ€™re now 100% in T-bills (including short sale proceeds)
awaiting new opportunities, and 40% invested in three short and two long (our
short proceeds finance our long trades) trades. Our model portfolio followed
up weekly in this column was up 41% in 1999, up 82% in 2000 and up 16.5% in 2001
â€” all on a worst drawdown of around 12%. Weâ€™re now up around 6.3% for the
year 2002.

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 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 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.

Upside breakouts meeting up-fuel criteria (and still open
positions) so far this year are: long
(
NCEN |
Quote |
Chart |
News |
PowerRating)
@31.95 (27.89 ) w/ 26 ops;
and long
(
QCBC |
Quote |
Chart |
News |
PowerRating) @32 (split) (31.24) w/ a 30.2 ops. Continue to watch
our NH list and buy flags or cup-and-handle breakouts in NH’s meeting our
up-fuel criteria — but be sure to only add names that are in leading groups,
and now only add two trades per week once again until the market environment
improves.

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 that is in a leading group to the
downside but only add up to two in any week (and only in the weakest groups)
until market weakness is more pronounced.

The key question continues to be whether the U.S. bear
market will continue on a new leg down, and how global economies and markets
will react to such an event. The market’s actions over the next few weeks will be
key. If the broad markets all make new lows on strong volume and weakness
continues, it will be a much broader bear market than weâ€™ve seen in decades â€”- and it has the chance of pulling the world back into economic trouble. Watch the
plurality of markets for clues as what the next move will be.

Addendum And Update
(7/15/02)

For the model portfolio, we had
2500 shares of QCBC originally purchased at 32 (2500
X 32 = $80,000, or 8% allocation per trade) which were mistakenly marked to
market at 31.24 last week instead of the stop-out of 32. This gives us $1900
more profit minus commissions of $50 = +1850.

On CWP we had 10,250 shares
(10,250 X 7.77 = 79643 the last 50 shares under 80,000, or 8% rounded down)
which were mistakenly marked to market at 7.84 instead of the stop-out at 8.2.
This gives us â€”3690, plus commission of 50 = -3740 on our model one
million portfolio. Negative 3740 + 1850 = So
we ended the week up $66,140 instead of $68,030, or 6.6% YTD.

I apologize for the error,
which I should have caught since our alarms went off for both stocks in our real
portfolios. Excellent job to those who
caught these errors before we did!

Hereâ€™s a brief update.
All but the Dow Industrials and Transports have made lows below the Sept.
30 lows. The world index is a hair from
making new lows. The bear market is
clearly on. The VIX and Sentiment are
overdone on the downside, but they may not work the same way in a bear market as
they did in a secular bull market before. The
market is ripe for a rally, but needs a catalyst that can push it up for more
than week or a few days. The real
question is whether the decline in the market will begin to impact the entire
global recovery. So far, commodities
markets are saying not yet. EMs are also
holding up reasonably well, particularly in Asia and Eastern Europe.
Investors need to watch carefully to see whether commodities prices
(nickel and tin and the CRB and Goldman Sachs indexes) along with the stronger
EMs start to fall in sympathy with further market declines, and whether US and
global bonds begin to rally toward their September â€™01 highs.
Unless these markets begin to take their lead from the US meltdown, we
canâ€™t assume that the global recovery will be aborted.
Watch carefully! Is another Fed
rate cut or other intervention action in the works?

Nail-Biting On Retest Continues

BUY THE FEAR, SELL THE GREED

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