New Bear Leg Commences!
For
many months we have been advising investors to be cautious and to watch the key
9700 Dow and 1200 SPX numbers as critical support that, if broken, would show
this to be a true bear market. The
Dow has now broken down out of a huge two-year head-and-shoulders top formation
with a minimum objective around just below the 8000 level, while the SPX has
CONCURRENTLY completed a huge head-and-shoulder top, taking two years to form,
with a MINIMUM downside objective of just under 1000. The plurality of indexes breaking out to the downside over the last few
weeks points to likely continued movement on the downside until these objectives
are reached — albeit with brutal and sharp bear market rallies interrupting the
decline periodically. THIS IS A
REAL BEAR, AND REAL BEARS ARE TREACHEROUS MARKET ENVIRONMENTS!
The
good news is that we’ve kept and built onto the great gains we pulled in since
March of last year when the market peaked. We have not been raking it in from this bear market, however.
Instead, we’ve been defensive, which is a lot better than most investors
and funds have done. And for the
first time in months, we actually got some short sales this week, as we will
discuss below.
On
the economic front, May Lumber DID complete a choppy head-and-shoulders bottom
formation last week. But May
Copper made new lows, AND June bonds made new highs — which means the plurality
of economic markets are still pointing towards economic weakness. However, when copper follows lumber and breaks out of a major bottoming
formation, or when bonds follow lumber and break DOWN out of a major topping
formation, then economic markets will begin to herald a turn around in the
economy approaching. We suspect
that only when all three of these markets break out of bottoming or topping
formations, will the markets be able to respond to the economy in a positive
tone. Wait!
Let’s
look at some numbers from the week. New
Highs versus New Lows
on our RS/EPS lists were 4/31, 1/75, 7/63, 2/39 and 4/94 — clearly the new lows have jumped out to massive
dominance now. We are no longer in a
downward trending trading range, as a new bear leg is clearly taking hold here. There were
0 breakouts on the upside with 20 breakdowns on the
downside of four-week-plus consolidations on our RS/EPS lists. We had two short-sale trades this week in both RG and CBST, as well as a
few close calls on the downside. Investors
should now continue to monitor closely for potential short-sales in the
sub-groups and groups that appear most frequently on our daily lists of bottom
RS/EPS New Lows group and sub-group summaries. We’re not quite in a get aggressive bear market mode yet, but we are
starting to get close — wait for real opportunities that meet ALL of our
short-sale fuel and breakout criteria (you might want to review our “art of
short-selling” lesson of a month or two ago).
Our
overall allocation is still VERY DEFENSIVE, with 84% in T-bills awaiting new
opportunities, and 16% in short-sales. 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 down about 0.3%, with a mostly cash position.
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.” 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.
We’ve been effectively defensive ever since, and are now as
defensive as possible.
Three
of the groups that have most frequently been listed each day on our Bottom
RS/EPS New Lows List groups and sub-groups charts over the last three weeks (and
dating back much longer than that) have been Telecom, Media and Biotech. We were pleased this week to finally get signals in two stocks in two of
these groups on the downside, Rogers Communications
(
RG |
Quote |
Chart |
News |
PowerRating) (a media-Telecom
stock) and Cubist Pharmaceuticals
(
CBST |
Quote |
Chart |
News |
PowerRating) (a Biotech). Let’s take a brief look at these valid signals on the short side.
RG
hasn’t made money since before 1995. Its
losses grow and decline, but it is always in the red. The
year 2001 is expected to show an acceleration in its loss to the most ever in
a year. Thus, earnings are
consistently negative. The stock
peaked near 35 in early 2000, declined to just below 25 and then underwent its
first sharp rally up to the 30 level over a nine-week period. From 30, reached in June 2000, it’s been downhill for
RG. It has declined to the 14.5 level in late November 2000. Since then it has formed a nice inverted cup-and-handle formation,
rallying to 20 and then hitting near 15 again and bouncing on lower volume
before breaking down last week on a high-volume thrust down to new lows. It is worth noting that on a weekly chart, RG also completed a huge
two-year head-and-shoulder TOP formation on this breakdown, with downside
projections near the 5 level. The
thrust down occurred on relatively high volume, just barely meeting our high
volume breakdown requirement. RG
has both high debt and high institutional sponsorship, just as we would like to
see in a short. Its EPS rank is 36,
well below 50, and RS is 20, well below 50. We sold on the thrust down and will look to lower trailing stops at the
earliest possible time.
One
of the weakest groups of this entire bear market cycle has been biotech, a
darling of the last bull market. Like RG, CBST shows losses in annual earnings and quarterly earnings for its history
since 1995. Losses have been
growing, and here, even revenues have been declining consistently. The stock peaked above 70 in early 2000, declined to below 20 in the
April-May massacre of 2000, and then embarked on a sharp bear market rally to the
64 level by September of 2000. Its
had a choppy decline to the 20 level again, with recent support coming in at
22.69. From this point it rallied
to 35.94, making a cup. The handle
has come right back down to the 23 support level, and the breakdown of last week
came on a large thrust down, with volume the fourth highest of the last six
months, where we sold it short on the close of the thrust down breakdown. The stock has a RS of 9 and EPS of 11, making it one of weakest earnings
and technical stocks in the market. While
debt is lower than desired, sponsorship is still quite high. It meets all
of our fuel criteria and broke down out of a valid inverse
cup-and-handle.
Upside
breakouts meeting up-fuel criteria (and still open positions) so far this year
are: none; and last week we had no valid
pattern breakouts up in stocks meeting our up-fuel criteria (see 10-week trading
course). 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.
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: Rogers Communications
(
RG |
Quote |
Chart |
News |
PowerRating)
@ 14.32
(13.35) w/16 ops; and Cubist Pharmaceuticals
(
CBST |
Quote |
Chart |
News |
PowerRating) @ 15.31 (15.31) w/24.25 ops
— both new positions
taken this week. 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.
Our
strategy remains simple and relatively cautious as well: protect against
whipsaws by waiting patiently for real low-risk highly
reliable trades that meet ALL of our criteria. The environment is becoming more clearly directionally biased to the
downside, but we won’t become aggressive toward shorts until breakouts in a week
double in number. Until then, let’s
remain a bit cautious and only add two shorts per week — only in the very
weakest industries, groups and sub-groups. Yes, this is a great directional move, but bear markets are very
treacherous, particularly when everyone starts to catch on to the trend. The Fed could ease at any time upon further market weakness, and this
could lead to big whipsaws on new and existing short positions. So we will not change our cautious stance for now.
Remember our goal
is to make consistently better-than-market returns (20%+
average annually) with relatively less drawdown risk than the market. Smile and think of the carnage we’ve just avoided from
the sidelines. When valid breakouts
of up-fuel or down-fuel stocks become abundant again, we’ll pounce with both
hands. Until then, we must tread
cautiously to avoid getting chewed up.