Remember This Truism

• June 18, 2004
• Mark Boucher

A Slippery
Climb

 

We continue to believe that
global equity markets are in a relief rally.  As long as interest rates don’t
pop up with bonds making new lows, and as long as oil prices don’t pop up to new
highs, the path of least resistance should be higher for equity prices, and
equities should gain on bonds.  BUT, investors should also realize that our
liquidity indexes are starting to turn negative in the US, and generally that
means not a-lot of upside potential to stocks, while risks are rising rapidly. 
Let’s not forget that liquidity has been THE primary force behind the entire
cyclical recovery from March 2003 to the present.

In addition, valuations are
again relatively poor.  And the risk of shocks have never been higher.  If you
were al Qaeda wouldn’t you attempt some more terrorism as elections come
close?   The temptation has to be HUGE.  Imagine if they win another election —
or even help unseat Bush.  Intelligence services and common sense both argue
that terrorists will try their hardest to make a mess from now through
November.  And that means a potential unimaginable shock could rock the markets
at any time.  Now if risks were low otherwise, value was good, liquidity was
strong, and opportunities were abundant and looked high reward/low risk, that
would be a different story.  But when valuations are already overdone, liquidity
is becoming negative, and breadth is just luke-warm, why risk much precious
capital?

 

 

 

In addition, investors need to
remain fixated on the triple threat — if bonds make new lows, the dollar makes
new highs, or oil makes new highs, the market will react swiftly and negatively,
and perhaps in ways and via asset-classes that are surprising.  Correlations
among asset-classes are most aligned in bear moves.  The dollar appears to have
peaked, bonds are in a relief rally that is likely to last months as investors
DID overreact and over anticipate tightening, and OPEC is doing their best to
bring oil back down to at least slightly more reasonable levels, so the
likelihood is that these pressures have eased for a spell. 

 

 

 

One of the ways investors can
get an edge in the market is by pulling back when things are not very sure, when
the environment doesn’t seem VERY GOOD or better, while being aggressively
allocated when odds do seem to be very favorable, trends are strong and forces
behind those trends seem very likely to continue.  That isn’t now — so we
continue to advise investors to be more cautious than usual here.

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. 

This week in our Top RS/EPS New Highs list published on TradingMarkets.com, we
had readings of 25, 32, 50, and 52 with 22 breakouts of 4+ week ranges, no valid
trades and close calls in WRC and REXI.  Upside breadth is continuing to
improve, and we are now eagerly awaiting trades that meet our criteria. 
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.  This week, our bottom RS/EPS New Lows sunk back to bull market
territory, registering readings of 8, 10, 7, and 6 with 5 breakdowns of 4+ week
ranges, no valid trades and one close call in IBC.

^next^

 

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 Great veteran Richard Russell writes often about the difference between how
a rich man and a poor man invests.  The rich man is patient — he doesn’t need
the money, and so he waits patiently and only risks his precious capital when he
believes the odds are very good and the potential profit is substantial.  The
poor man feels he needs to be making money all the time, and so he over-trades
and puts as much capital at risk in poor-odds markets as good-odds ones.  And
over time the rich man makes substantially better returns with less risk than
the poor man.  Remember this truism.  Traders often act like the poor man,
craving action and wanting to trade no matter what.  But a big part of what
allows a trader to cut drawdowns and be ready to fully exploit strong
opportunities lies in knowing when to mostly stand aside.

Mark Boucher

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