Overdone Sentiment vs. Massive Stimulus — No Clear Winner Yet

• July 11, 2003
• Mark Boucher

The
market remains in a precarious place somewhere between
correction and consolidation. Sentiment indicators have risen to levels that
nearly always herald a correction. The Insider buy/sell ratio is also quite
negative, particularly in the tech shares. However, as we have highlighted for
weeks, the US and global central bankers are engaging in an all-out campaign
against deflation and inflation. It is not yet clear whether overdone sentiment
will be able to overshadow the most massive stimulus markets have witnessed
since the 1900s. Therefore we continue to strongly suggest investors watch for
distribution days (high volume down days of 1% or more on the major averages)
and for all the major indices to close on strong volume below intermediate
support zones: S&P below 960, Dow below 8940, and Naz below 1590. Conversely,
watch for accumulation days and new highs on strong volume in all the major
indexes above 1025, 9375, and 1700 respectivel, to confirm a new leg up,
although we would expect a period of consolidation or correction here.

Global Equity leadership in China,
Thailand, India, Russia, Latin America, and small-cap value in Emerging Markets
in general has so far been unphased by the developed market consolidation. These
markets will probably hold up well unless the above support levels in US indexes
are breached. Often the strongest EMs will move higher or stay high until a
higher volume more serious correction develops — in which case they play catch
up on the downside for the final phase of the correction. 

In the US market, the internals are confirming a mini-bull scenario. The leading
sectors continue to be biotech and medical related, telecom and Internet
related, Home Building/RE/Mortgage, Natural Gas and software. Small-cap value is
the leading segment of the market, which is consistent with the pre to beginning
inflation part of the cycle (late cycle). Downside leadership for shorts is
barely existent. 

Unfortunately, the current tightrope the market is balancing on with overdone
sentiment and overvaluation on one side, and massive fiscal and monetary
stimulus on the other, is likely to be indicative of the period ahead. We still
believe that aggressive central bank and fiscal action will lead to brief,
volatile mini-manias. This means Investors will have to be extremely flexible
and very nimble to do well in this environment. As always, watch for
confirmation by breadth and internals before moving into any asset class
aggressively — and be ready to pull the plug on nearly any stock investment at a
moment’s notice.

To add to the high-wire act, many intelligence services are reporting a
potential substantial pickup in the Iraq war may be developing in the weeks
ahead. Investors should prepare for a potential re-expansion of action against
guerrilla forces that may cause volatility in the markets, if it develops.

Investors should continue
to cautiously add stock exposure as trade signals are generated that meet our
strict criteria. Our model portfolio followed in TradingMarkets.com with
specific entry/exit/ops levels from 1999 through May of 2003 was up 41% in 1999,
82% in 2000, 16.5% in 2001, 7.58% in 2002, and we stopped specific
recommendations up around 5% in May 2003 — all on worst drawdown of under 7%. 

Last week in our Top RS/EPS New Highs list published on TradingMarkets.com, we
had readings of 40, 94, 114, and 99, accompanied by 16 breakouts of 4+ week
ranges, and one valid trade in
(
SFNT |
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PowerRating) and a close call in
(
IVIL |
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PowerRating). With
new daily highs again above 20 consistently, the market has a shot at continuing
the rally as long as these hold up. The action continues to rate as cautiously
bullish biased, but nothing like that of the great bull markets of the 1980s or
1990s. On a major secular bull move we would see hundreds of breakouts in close
calls or stocks meeting our criteria, not just 16. 

Remember to try and position in valid 4 week trading range breakouts on stocks
meeting our criteria or in close calls that are in clearly leading industries,
in a diversified fashion. Bottom RS/EPS New Lows remained non-existent last
week, as they have been since mid-April, showing low readings of 1, 1, 0, and 0,
with 0 breakdowns of 4+ week patterns, no valid trades, and no close calls, so
the short-side remains muted. 
Continue to watch our NH
list and buy flags or cup-and-handle breakouts in NH’s meeting our up-fuel
criteria that are in leading groups, but add no more than two positions a week.

For those not familiar with our long/short strategies, we suggest you review my
book

The Hedge Fund Edge, my course “The
Science of Trading,”

my video seminar, where I discuss many
new techniques, and my latest educational product, the

interactive training module. 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 long
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 of change in the new-economy/old-economy theme appeared to
be upon us. We’ve been effectively defensive ever since.

On the long side we like
(
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PowerRating),
(
AVID |
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PowerRating) and
(
UNTD |
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PowerRating) still and the
close calls of last week were
(
DRIV |
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PowerRating),
(
GLDN |
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PowerRating), and
(
RTLX |
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PowerRating), and
this week
(
IVIL |
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News |
PowerRating). No short-side opportunities have developed via our
strategy for some time. We also like conservative gold stocks, like FCX pfd A
and
(
NEM |
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PowerRating), some broad EM exposure like DEMSX, Eastern Europe, China, and
Thailand, in particular.

 

Technicals and breadth should confirm whether the massive
liquidity infusion is going to have traction quickly, or whether a more
meaningful correction is upon us. Hold only your strongest positions now and
wait to rotate into new breakouts once this consolidation/correction is over.  
Continue to watch for clear leadership in leading new industries and plurality
of breakouts in those industries, for follow-through by close call and criteria
stocks, for breakouts by the averages that will confirm if this bear-market
rally has legs, and for further breadth thrusts, to tell us that a better
bullish cycle is developing here. 

Mark Boucher