No Follow Through Or Breadth Thrust Signals Yet
Following July 24’s big reversal day,
we are anxiously awaiting a breadth thrust or a follow-through
day as the first sign that a possibly-catchable bear market rally will emerge
off of extreme oversold and overdone sentiment levels. We’re still waiting. Continue to watch for breadth thrusts
like a 9:1 up/down volume day, the five-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. And continue to watch carefully now for at least
one — and preferably a couple — good O’Neil Follow Through Days as a sign that
some sort of rally is emerging.
However, we would continue to not be surprised to see one or two 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 on any
potential rally. We also wouldn’t be surprised if we got new lows into the fall
before this type of action emerges. Yet the market can do anything anytime — so
watch and let it signal to you with its own action what it is likely to do in
the period ahead.
Last week, we mentioned that another thing this market needs to be able to
prove it can do before a decent rally develops is shrug off some probably weaker
economic news and some negative earnings surprises. So far, this type of
strength in the face of bad news is not yet developing. Without clear signals
like breadth thrusts, follow-through days, or positive price reaction to
negative new, the main trend (down) deserves the benefit of the doubt.
And especially since the the last minor leg of the bear market took nearly
everything down with it, investors should be very cautious and extremely
patient. It’s not fun, but in some environments, preservation of capital is the
key. Some market environments are relatively easy to make money in. Most bear
markets are not. Even selling short can be risky when a market is very
oversold. So cash is still looking awfully good right now, I’m sorry to say.
Since March 2000 the world index is down over
45%, the S&P over 48%, the IBD
mutual fund index is down over 62%, and the Nasdaq has crashed over
76%. Meanwhile since March 2000 the long/short strategy we summarize and follow
up each week in this column has made more than 38% on a worst drawdown since
then of under 6%.
Now clearly we are underperforming our long-term growth rate during this period,
and it is hardly thrilling to have been so heavily in cash since March of
2000. But investors have to realize that keeping risk low and slowly building
less-than-average gains in a dangerous environment is still a big victory for
any strategy when nine out of 10 investors are getting killed. Sometimes just
playing good defense is the most important aspect of winning the game.
Unfortunately, we’re still in one of those periods. But even if this bear market
lasts many years longer and we get a decade of mini-bull and mini-bear markets,
investors using this strategy should be able to do quite well via this strategy
with minimal risk. Remember low-risk investing is streaky — there are periods of
substantial gains (41% in 1999 and then 82% in 2000), and there are periods of
less impressive ones.
But if your average returns are over 20%
and you can keep risk and volatility to a minimum, you’re accomplishing your
goals and you’re doubling your money every 3.5 years (taxes not considered). And
that’s worth getting excited about! So yes, this may not be the most fun period
investors have ever faced, but maintain your discipline and your defense, and
the next time we get the ball by getting a better investing environment, we’ll
be able to go after opportunities with confidence to produce steep gains, again
and again.
This week, while new
lows on our lists outpaced new highs consistently, we still did not get a valid
trade on either side of the aisle, although we actually got close calls on the
buy side in
(
BLUD |
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PowerRating) and
(
JCOM |
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PowerRating), and a few close calls on the sell side
such as
(
TLGD |
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PowerRating) and
(
ABV |
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PowerRating).
I’m sure that many traders are tempted to play close calls. And you can
certainly do so, AS LONG AS YOU BALANCE SHORTS AGAINST
LONGS UNTIL WE GET SOME CLEAR SIGNALS THAT A CATCHABLE RALLY IS EMERGING.
But, realize that in this type of environment, one may end up lucky to break
even on close call trades in total, and it is unlikely that the profits will be
worth the effort. We continue to expect investors may have to adjust to a
lengthy period of global multiple convergence, where overvalued US stocks have
trouble rallying en masse for many years, while certain sectors present
limited but good opportunities on both the upside and downside.
Top RS/EPS New Highs did strengthen
some this week, but remain weakly below 20 a day consistently with readings of
3, 8, 21, 20, and 15. We would typically expect a better rebound in new lows off
of a potential bottom. Wait now for at least a follow-through day before
anticipating even a multi-week rally. And wait for solid leadership in the
breakouts before thinking about getting aggressive on the long side.
Bottom RS/EPS New Lows barely stayed above 20 but did so with readings of
114, 35, 27, 35, and 29. Following last week’s strong readings and this week’s
continuation above 20 the trend still looks to be down until proven otherwise,
despite the incredible degree of overdone sentiment and oversold levels. The
breakout and breakdown numbers are still weak on both sides of the tape, meaning
few even potential opportunities compared to a more typically abundant
environment. Sometimes heavily on the sidelines truly is the best place to be.
There will be plenty of good opportunities when the environment changes, so be
patient.
Our official model
portfolio overall allocation remains ULTRA DEFENSIVE. We’re
now 100% in T-bills (including short sale proceeds) awaiting new opportunities,
and 16% invested in two lone short positions. 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 around 5.28% for the year 2002. Let’s
wait for a bit better environment before positioning heavily.
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 US 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:
NONE. 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.
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 — Ilex Oncology
(
ILXO |
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PowerRating) @13.76-out on 13.1 ops (poor stop placement here,
sorry); and Arrow Electronics
(
ARW |
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PowerRating) @17.97 (16.61) w/ a 21.25 ops (lower the stop to 18.2 on
a move below 15.7). 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 volatility is more normalized.
The major and most critical question regarding the markets
is still unanswered: whether this new bear market leg will actually carry
to global recovery down the toilet into global recession and a very negative
scenario.
In Japan 1990 and US 1929, the central bank tightened after the bubble had
popped and did not loosen policy until the bear market had clear hold of the
markets. However, this time is different in the US bubble. The Fed began easing
very quickly and eased very aggressively. A global economic recovery has
actually started off of a quite shallow recession. The Fed will have to act
again quickly and get concerted intervention to prevent the current market
weakness from taking the global economy down with it. But we suspect they will
engineer another saving attempt at least because Greenspan knows the danger and
the cost. Will he save us from a brutal global recession now and further global
deflationary disaster?
So far, commodities and bonds are getting worried, but not yet discounting
renewed recession. Continue to watch closely though, as this may be the most
important period in your economic lifetime directly ahead. Amazingly, the
Nasdaq
(
$COMPQ |
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PowerRating) has now fallen to the
average percentage decline levels for this much time from the tops of the 1929
US crash, the 1980 gold bear market, and the 1980 peak in Japan (three other
major manias this past century). Now, if the Nasdaq follows script, we could
have a sharp rally soon followed by 5+ years of sideways action. We will
continue to try and navigate these treacherous markets aiming for decent gains
with relatively low-risk and safety. Again, please stay tuned, now more than
ever.
Until next week,
Mark