Retest Marches Onward

• August 10, 2001
• Mark Boucher

The
retest of the March-April lows continues and seems to not show any signs of
ending. We still
need some follow-through days and evidence of breadth entering the market on the
bullish side before we can assume an intermediate-term low is upon us.
Continue to watch closely for two or preferably more of the
breadth-thrust indicators we’ve been enumerating for the last few weeks to
materialize before getting exciting about a sustained bullish move.
 

Economically
sensitive commodities are generally not looking very favorable.
Bonds are behaving bullishly, copper is making new lows and has been the
best indicator of future stock market trends for the last couple years.
Lumber is rallying, which is the main plus, while cotton is either
consolidating or basing, but not yet showing anything significant enough to
suggest a bottom in the economy. A sharp
move down by bonds and up by cotton and copper will tell us that the markets are
finally starting to anticipate a sustained economic recovery.
Until we get this, we would be surprised to see a sustainable up-move in
stocks in general. 
 

A
look at the numbers from our stock lists tells us that the trading-range
environment continues, although the bears gained ground last week. But remember the pattern of the last six months
— any time breadth tilts
slightly to the bull side, within a week or two the market shifts again, and the
same happens when breadth tilts slightly to the bear side. Wait for real indications of breadth one way or another, which appear
absent right now. New
Highs vs. New Lows on our RS/EPS lists were
28/6, 19/6, 21/3, 13/6 and 15/10 — showing no strength to the bulls or the
bears once again. Continue to watch for something real —
like days of new highs or new lows on our lists above 50 daily and above 100 a time or two
each week again before becoming eagerly bullish or eagerly bearish. While top RS/EPS new highs appeared to slightly edge out bottom RS/EPS
new lows, the quality of new lows was substantially better than new highs this
week. There were just seven breakouts
on the upside to new highs of stocks on our Top RS/EPS New Highs lists with no
close calls, while new low
breakouts numbered eight, but with two new short positions — Global Crossing
(
GX |
Quote |
Chart |
News |
PowerRating) and
Phelps Dodge
(
PD |
Quote |
Chart |
News |
PowerRating) — and two close
calls as well — DuetcheTelekom
(
DT |
Quote |
Chart |
News |
PowerRating), volume substandard, and Verity
(
VRTY |
Quote |
Chart |
News |
PowerRating),
which showed no downside
earnings momentum — the best showing in terms of quality of breakouts of new
lows in many months. Close calls are stocks almost meeting our criteria that broke out of sound
bases. We want to see dozens of breakouts or breakdowns in stocks meeting our
criteria or close calls on the one side or the other before becoming
agressively allocated. The environment thus remains not yet
nearly optimum on the long side or the short side and is
currently not even biased one way or the other. Watch carefully next week to see if downside momentum continues to build
or if this is yet another fake-out.

Our
overall allocation is now DEFENSIVE, with 76% in T-bills awaiting new
opportunities. Our
model portfolio followed up weekly in this column ended 2000 with about an 82%
gain on a 12% maximum drawdown, following a gain of around 41% the prior
year.  For year 2001, we are now
up about 5.3%, with a heavy cash position.

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” and course “The Science of Trading.“
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. 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. 

Upside
breakouts meeting up-fuel criteria (and still open positions) so far this year
are: Doral Financial
(
DORL |
Quote |
Chart |
News |
PowerRating) @36.1 (37.3) w/31.75 ops. Continue to
watch our NH list and buy flags or cup-and-handle breakouts in NH’s meeting our
up-fuel criteria — but continue to add just two per week and only in leading
groups.

On
the downside, 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: Global Crossing
(
GX |
Quote |
Chart |
News |
PowerRating) @6.05 (6.11) — now use 7.35 ops;
and Phelps Dodge
(
PD |
Quote |
Chart |
News |
PowerRating) @38.1 (36.54) — now use 41 ops. 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. Here
too, remain cautious by only adding two shorts in a week, until we get
more consistency in the number of downside breakouts in a given week off of our
Bottom RS/EPS New Lows lists.
 

This
week GX and PD both met our criteria and had fair breakdowns of trading ranges
that were four-weeks plus. PD had a
nice gap-on-decent-volume breakdown, while GX had a thrust down on a gap on
strong volume. Both have declining
earnings, declining momentum, poor RS and EPS ranks and are in industries that
are ranked among the lowest. We’ll
have to watch closely to see if this increase in the quality of downside
breakouts will lead to a decent downmove or not — hopefully at least in these
selected groups.

Scant
opportunities are developing in either direction here as the retest trading-range market environment goes on and on and on. Patience and selection will continue to pay dividends, although investors
should be prepared for some whipsaws in this environment. Continue to tell yourself the truth
— it only takes a couple weeks of
good environment to make a year’s worth of profits in these markets.