Need More Earnings Juice
This
week the S&P 500
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and Nasdaq
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broke last week’s low, while the Dow
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low and rallied. Since all three
indexes didn’t break decisively to new lows, the levels we spoke of last
week were not broken completely.
Investors
should now watch this week’s lows carefully. If
all three indexes break decisively below this week’s lows, investors in
Emerging Markets will have to adopt a more cautious stance and take half profits
at least as the U.S. market will then begin to pull the rest of the markets down
with it. For now, some Asian markets are
making new highs this week, Eastern European markets are making new highs this
week, and junk bonds are making new highs.
The big news this
week is a more general acceptance of a slowdown in the US rate of recovery.
Korea also raised rates, perhaps prematurely. Watch
the U.S. and global market lows of this week for signs that the developed
markets will begin to bring everyone down with it and take profits at such a
sign.
Despite the weak
indexes, the leadership of the bull move is still fairly strong.
Our longs were all up sharply again last week, while our short took it on
the chin in Wednesday’s short-covering rally. Note
that Wednesday’s rally had meager breadth (3/2 advances to declines on NYSE
and only 2/1 on Nasdaq). We’re going to
need more breadth and another breadth thrust in the indexes before we can even
anticipate another rally within this broad trading range.
The week was decent for existing leaders such as housing and retail, but
poor for the broad market and for techs in particular.
This market is looking like the mirror opposite of the 1998-early 2000
market. But the techs
continued rallying into March 2000, when they too finally fell and played
catch-up in the bear move. Now we have
the A/D advancing, the broad market rallying, some thin leadership doing quite
well, while the techs continue to decline.
Could the techs spend another one to two years groping for a bottom while the
small-cap value and thin leadership sectors rally?While breadth so far
is not yet making us very worried about the market environment, investors should
be aware that there is a potentially ominous picture forming in the markets. The
S&P 500
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monthly chart head-and-shoulders pattern that would be completed on a solid break below the September
lows around 950.
The dollar index
would complete a large weekly chart double top on a solid break below 111. The AUD, NZD, and EUR would all complete weekly chart double or triple
bottoms on moves above 55, 46, and 94 (then 96.5) respectively.
Finally gold would complete a huge double bottom on the monthly chart on
a solid close above 340. All of
these occurring would be an ominous sign that the dollar and stock bubble are
deflating rapidly and we’re headed for a more inflationary environment where
assets outside of the U.S. are the main protection of capital.
We don’t yet see signs that this dark scenario is developing in terms
of market breadth — but investors need to keep this potential scenario in the
back of their minds. Inflation
would favor hard assets, other currencies, EMs, commodities, and real estate,
should this develop. It’s not the
odds favorite right now, but don’t miss a huge sea change if this develops.
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We do expect the AUD and NZD to break out, regardless of the inflation scenario, as the global
recovery continues to unfold. And
the dollar weakness that is finally in a consolidation or correction, should
eventually reappear. Keep in mind
that a fast dollar decline that is not orderly will threaten the global recovery
too.long
trading
range in developed markets, similar to the environment of 1965-1982, with
intermittent mini-bull and mini-bear moves for the next 5+ years. EMs
may be launching a secular bull market that would be much more
profitable and playable.I have been talking
for some time about how normally at this stage of the recovery earnings gains
begin to take over from monetary stimulus as the fuel behind stock price gains. But so far it has been relatively profit-less for U.S. companies. Is the Cisco/GE improved outlook the beginning of the earnings phase of
the recovery? Watch
for breadth and leadership before anticipating any kind of real rally developing
— and then only expect a potential mini bull move
In the meantime, our
US long/short strategy continues to show reasonable gains with very low risk
this year.(
GAN |
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PowerRating), and
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PowerRating). But unfortunately, the breadth of Top RS New Highs has been far below
real bull market levels, and so the number of opportunities has been quite low,
as has our allocation. We’re
making money at a 20%+ 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
we’ve seen in the homebuilding industry this year. And while our strategy profit is decent, it isn’t as large as those
investors who have taken our suggestion and ventured into the Emerging Markets
— where we suspect most of this year’s gains will be made.
Continue to monitor
the commodity markets. Economically
sensitive commodity indexes and markets are on the whole still positive the
recovery scenario, though weakening. Weakness
now in copper, cotton, Lumber, and commodity currencies, accompanied by further
strength in global bonds, would signal a softening in growth and a change in
scenario. Breakouts up in NZD and AUD as well as in Cotton, Copper and Lumber
would signal a reacceleration of the
global recovery. Remember to
let the plurality of markets be your guide.
Top
RS/EPS New Highs exceeded 20
every day this week, despite weakness in the averages. However there were only 8 breakouts this week with no new trades, so the
quality of the upside action was quite poor. Bottom
RS/EPS New Lows did not rise above last week’s high of 52 and contracted
to just two on Wednesday’s big rally, despite being above 20 every other day of
the last week. The downside
argument is hardly compelling here now either, as only nine breakdowns occurred
during the week with no new short trades meeting our criteria. all
our criteria that are also in leading or lagging groups according to our last few weeks of sector and
sub-group lists.
Our overall
allocation remains DEFENSIVE.
We’re
now around 27% long and 8% short, with about 72% in T-bills (including short
sale proceeds) awaiting new opportunities. Our model portfolio followed up
weekly in this column was up 41% in 1999, up 82% in 2000 and up 16.5% in 2001
— all on a worst drawdown of around 12%. We’re now up over 9% for the
year 2002, mainly driven by a select couple of names which is often the case in
a market that is searching for leadership. Due to the volatile nature of the
U.S. market, we will probably see more frequent and larger drawdowns than
we’ve had so far.
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: Garan
(
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(
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ops; and Group
One Automotive
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PowerRating) @44.84 (47.52) w/ a 43
ops. Continue to watch our NH list and buy flags or cup-and-handle breakouts in
NHs 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.
On the short side
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:
(
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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 until market weakness is more pronounced.
Traders and
investors now need to be nimble and canny. Watch the plurality of the markets in general for clues on how to move
next. Further indication of
recovery will improve the U.S. market environment and continue to give EMs a
push. Deflationary and inflationary
scenarios also need to be monitored. And
leadership and breadth should be watched like a hawk.