Remember This About Volatile Markets
How
quickly will the Fed tighten and how soon will that tightening pace begin to
bite the economy? Watch next week’s job report carefully — strong
job growth will push the Fed faster, whereas sub-par job growth will give them
the excuse to slow tightening down the road. It is not clear yet whether the
market has peaked in its cyclical rally or is going to embark on another leg up
before peaking later this year following the current correction. Plurality
signals are not yet sufficient to give good odds to either scenario. What is
clear is that late cycle groups are outperforming — and this should be the case
whether we’ve started a new bear or are just correcting prior to a last leg up.
Aggressive traders should
therefore move to a fairly balanced long-short portfolio and tread lightly,
while most investors should be mostly sidelined here. We like value over
growth, Oil Service/S&P, and staples and non cyclicals over cyclicals and the
market. Watch large cap value over small cap. DIA/QQQQ probably has some room
to go as well. Our favorite groups showing strength are staples, managed care
(watch health care for beginning outperformance), energy, staples, growth
Europe, European financials and some Asia;Â while the weakest groups are tech,
consumer discretionary, Air freight, autos, brewers, US financials.
Remember, remember, remember
that a volatile and negative market environment can take the best trading system
and turn it into junk. So play defensively and stick to paired trades or cash
until a clearer environment develops so you have a full deck of capital to
exploit when opportunities are better. The key to making money in the long-term
is only committing significant allocation to trades when opportunities are
highly in your favor and have substantial potential versus the risk — and when
that is not the case getting out and avoiding risking precious capital. Await
good signals of a better breadth and upside volume environment before beefing up
allocation to any trades here via our strategy.
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 (strict following of our US only methodologies should have had portfolios
up 17% for the year 2003) — all on worst drawdown of under 7%.  This did not
include our foreign stock recommendations that had spectacular performance in
2003.Â
This week in our Top RS/EPS New Highs list published on TradingMarkets.com, we
had readings of 18, 11, 18, 26, and 34 with 14 breakouts of 4+ week ranges,
valid trades in USAP and LCAV and one close call in HOLX. Breadth has now
dropped below the 20 consistent number desired for a favorable investing
environment for Top RS/EPS new highs. This week, our bottom RS/EPS New Lows
recorded readings of 11, 11, 18, 10, and 12 with 7 breakdowns of 4+ week ranges,
one valid trade in JBLU and one close call in SUP. Valid signals remain in
place in MLI and BHP.   The balance of longs and shorts and breadth in top RS
NH’s versus bottom RS NL’s has now clearly shifted away from a positive biased
environment.
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, and did not get to a fully allocated long exposure even
during the 2003 rally.
The key markets to watch are crude, the dollar, and bonds, along with junk
spreads. Crude was trying to rally but backwardization warns that this is
unlikely to be a launch to new highs and the uptrend could have trouble. This
weekend’s OPEC meeting is unlikely to resolve anything. Oil stocks are stronger
than crude itself. Nonetheless a strong move over $50 would be negative for the
market, whereas a weak close under $40 would be positive. The dollar’s
correction up is wreaking havoc upon non-oil commodities, currencies, and global
stock markets. The Euro is camped between 1.2950 and 1.3150 — the breakout of
this range could signal the direction of the next move and our guess would be a
stronger dollar. A stronger dollar will hit global equities while a weaker one
will provide fuel for a rally. Bonds need to remain the relief valve and rally
into any equity declines. But bonds are overvalued and not a great play unless
you expect deflation. The nightmare scenario would be a weaker market and
weaker bond market. Junk spreads appear to be one of the targets of fed
tightening and should widen. A significant widening will indicate unwinding of
excessive speculative positions and could lead to a panic in global markets.Â
Investors should stay defensive and watch these key variables to ascertain the
market’s next moves.
Mark Boucher