No Whites Of Their Eyes Yet

Better relative strength among foreign markets in this rally would also be
helpful. So far, Eastern Europe (Czech particularly), Russia, and Turkey are
leading the rally.  Asia needs to show better relative strength and net
performance. Watch for EWT to break out above 9.25 and EWY above 22.2.

Especially in a relatively uncertain environment, it is especially useful to
consult a broad array of markets in many different asset classes to confirm that
global markets are discounting a particular scenario — and that’s what much of
the above is concerned with. But don’t forget that much more critical than
confirming action with a plurality of markets is making sure that breadth and
leadership are solidly in the direction of your trading. Until that is the case,
the market is not a very good place for investment opportunities.  Knowing when
to stay out is as important to long-term success as knowing when to jump in.

Thus the breadth and leadership of the rally since the 10/10 lows is still
somewhat disappointing and not yet indicative of the type of action we need to
be able to participate in the market on the long side with any type of
significant allocation. We have had one follow-through day on the 14^th
, and one breadth thrust during this rally. We need more breadth thrusts like
another follow-through day up, a 9/1 up/down volume day, 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.

True, since June we’ve had both a 9/1 volume day and an 11 day ma of a/d over
1.9, which is the best showing via volume thrusts the market has displayed since
the October 1998 lows. But so far, the rally has been very choppy, it has been
mainly concentrated in the weakest stocks of the prior bear move, and leadership
has not materialized clearly, nor has volume been clearly indicative of
follow-through.  If volume, breadth and leadership can emerge, we suspect this
rally will develop into a B move, the best bear-market rally we’ve seen since
the March 2000 peak. But until we get volume, breadth, and leadership it’s all
guesswork that won’t make us any money.

Our methodological insistence on waiting for breadth and leadership has paid
huge dividends over the years, particularly since the March 2000 high. We were
able to make some profits from leading stock breakouts in the 2001 March to May
rally and in the Sept. 2001 to March 2002 bear market rally (and exit with some
profits via trailing stops). And we have been able to avoid participating in
fakeouts like July to August rally of this year. The market barely showed enough
leadership and minimal breadth in the earlier bear market rallies, but not
enough in the July rally of this year. Avoiding these traps has helped us make
positive returns every year following our windfall gains in 1999-2000. Where
does this leave us now?

So far the current rally also does not YET show the
leadership and breadth needed to give us at least an intermediate-term push that
could propel some leading growth stock breakouts up enough to allow us to
profit.  In the 2001 bear rallies, new highs rose above 20 each day for a week
consistently and some groups showed clear leadership.  In the rally off of July
of this year, new highs on our Top RS/EPS new highs list
NEVER reached over 20 consistently for a week. The current rally off of
10/10 shows the same problem so far — no week with consistently over 20 new
highs on our Top RS/EPS new highs list, and no clearly solid leadership.

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 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: NONE. Continue to watch our NL
list daily and to short any stock meeting our down-fuel criteria 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 we get better breadth numbers on the downside and better leadership.

The markets may need to test the lows and get reinforcements from the ECB and
other central bankers in fighting global deflation before a decent rally can
take hold. Even short-term traders like our own

David Floyd have noted the recent lack of follow-through in the
market. Before risking capital in this uncertain environment, make sure the
market has grown some teeth here in the form of breadth and leadership.  Without
that, the opportunities are limited and the risk is high.

Now is a good time to begin watching our new high lists carefully for
indications of potential breakouts of stocks meeting our criteria, and for
evidence that leadership and broader participation is developing. Wait for
breadth and leadership before participating.

Until next time,