Retest Or Minor Bounce?
This week’s lows bounced off of the lowest
support levels possible. However, the bounce did come off of a
Fib support level in a Fib time-frame, so we could get a decent short-term
bounce off of this level. The bounce off of support also came a day after the
Fed’s inaction and expectation that the economy would recover on its own,
despite unusual dissent from two Fed governors that the Fed should ease.
Breadth of new lows on our
Bottom RS/EPS New Lows lists declined sharply during
yesterday’s rally. Now a move over 880 in the cash S&P
500 along with a
follow-through day and expanding upside breadth COULD
even allow this rally to test (or even slightly exceed) the August
highs. Conversely, a close under 815 would likely mean new lows and another wave
down to force the central bankers into action.
These are the levels short-term
traders can watch. However the intermediate-term to longer-term picture remains
unchanged. A SUSTAINABLE and
RELIABLE rally phase appears unlikely until we get some concerted central
bank easing accompanied by substantially better breadth numbers.
We still will be watching for a
possible low between late summer and early winter in the market, followed by a
better rally than we’ve seen since March 2000 — a “B†wave rally for
Elliotticians. However, unless breadth becomes very impressive in the current
minor rally, we suspect that a new downwave in stocks and further economic
crisis will be needed to kick global central bankers into the concerted action
that is likely needed to help fuel such a rally. And so, absent new war news, a
retest or another decline to new lows, possibly in climactic fashion, may have
to occur before a meaningful rally can develop. Whether these new lows occur
off another short-term rally to or slightly above the August highs or not,
remains to be seen.
One shred of
evidence so far in support of another minor rally before the next wave down, is
the action of global bonds, which have reacted down in sympathy with the stock
rally. As long as bonds continue to show weakness along with equities strength,
the rally should have more room. However the longer-term bond picture is
negative, with bonds breaching levels associated with very weak economic growth
already. Global bonds are about as overbought as they’ve been for many decades.
Investors need to realize that.
When even slight evidence materializes that the
market can rally and the economy is reaccelerating, bonds will get trashed very
quickly. But, we don’t yet see enough evidence of this for anything but a minor
reaction in bonds. Remember that in a deflationary environment, bonds move
OPPOSITE to what one would expect in the normal
liquidity cycle. That means a sustainable rally in stocks would be accompanied
by a sustainable decline in bond prices, not the other way around.
Unfortunately,
Corporate yield spreads are still levels that are discounting a near depression
(in fact yield spreads are so high now and value so prevalent in corporate bonds
that should a recovery develop, these may make a better holding than stocks, as
they did from 1991 to 1995). In addition, Asian markets and economies are now
showing signs of weakening.
Oil prices, rising in response to war risks, are
acting as a drag on Asian, and global economies. Commodity prices show a mixed
picture, but are also not inconsistent with further economic
retrenchment. Cotton, copper, and lumber are all showing weakness. Gains, softs,
and oils are indeed fueling higher overall commodity prices, but each of these
moves is in response to supply shortages, not increased demand fueled by
stronger economic growth.
Uncertainty and war
risks are also high. Bush is tirelessly pushing for UN and more public
Congressional approval to attack (there is some evidence that Bush has received
the approval from Congressional Leaders to attack if further solid evidence of
Saddam’s nuclear arsenal shows up). The Democrats brought Al Gore to the fore
to try and change public perception and allow them to delay any attack until
after the election without negative political fallout. The public is mixed
though biased against attack, yet the intelligence information regarding Iraq’s
ties to the 9/11 crisis and Saddam’s accumulation of nuclear material is
compelling enough to argue for nearly immediate attack. But Bush cannot release
intelligence information to the public or even the main body of Congress without
compromising key sources that need to remain intact during any conflict. UK and
Israeli leaders are trying to help Bush by releasing some bombshell facts
regarding Saddam’s capabilities.
We still suspect that Bush is a political enough animal that he probably will
not act before getting more overt Congressional or UN approval. Thus the attack
is VERY LIKELY to occur, but could take place
anywhere between now and early the second quarter next year. Early next year,
the weather improves for an attack. The markets are beginning to get used to
this uncertainty, but they still don’t like it. A strike will need to
successfully isolate Saddam within two-three weeks to push markets ahead, if it
does develop. But while the markets must wait for the hat to drop, it is
unlikely that they will be able to undergo a serious rally.
Therefore we
continue to suggest investors wait and watch for more indications of better
breadth on a large number of fronts. Look for more strong rally days on
ABOVE average volume. Watch for another breadth
thrust up, like one or two more follow-through days, another 9:1 up/down volume
day, the 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.
The market needs to show that it can and will rally on negative news.
Foreign stocks need to participate in any rally to a better extent. Commodity
prices need to react not just to shortages and war fear, but to stronger demand
for a real recovery to become evident. Bond prices need to retreat significantly
in response to expected stronger economic growth before the recovery is more
certain. Junk bond spreads need to narrow in response to better economic
perceptions. And we probably also need clearer signs of concerted global
monetary stimulus and a Fed rate cut before the stock and economic environment
improve dramatically enough to warrant the risk of substantial long equity
allocation. Most importantly, wait for a much larger number of new highs on our
lists and breakouts of valid 4+ week consolidations in stocks that at least
almost meet our criteria, before thinking of allocating aggressively to this
market.
Until we get substantially better evidence of a
potential rally, our strategy remains ultra defensive, but continues to slug out
small gains.
Since March 2000
the world index is down over 45%, the S&P over 48%, the IBD mutual fund index is
down over 62%, and the Nasdaq has crashed over 76%. Meanwhile since March 2000
the long/short strategy we summarize and follow-up each week in this column has
made more than 38% on a worst drawdown of under 6%.
While this performance is certainly
underperforming our long-term growth rate, and it is hardly thrilling to have
been so heavily in cash since March of 2000, we have managed to eke out gains
with very low risk in a very dangerous market environment where 9 out of 10
traders have been big losers. We will hope and watch for a better environment,
but wait patiently until it arrives before risking significant capital.
Our official model
portfolio overall allocation remains EXTREMELY DEFENSIVE.
We’re now 88% in T-bills awaiting new opportunities.
Our model portfolio followed up weekly in this column was up 41% in 1999, up 82%
in 2000 and up 16.5% in 2001 — all on a worst drawdown of around 12%.
We’re now up around 6.65% for the year 2002. Let’s wait for a bit better
environment before positioning heavily.
Top RS/EPS New Highs never mustered up
one single solid week of consistent +20 or higher readings since the 7/24
lows. Readings this week were 6, 5, 2, 2, and 8, with only a
NO breakouts of 4+ week consolidation patterns and
no close calls.
Bottom RS/EPS New Lows managed another strong week consistently above 20
consistently this week, with improved readings of 114, 87, 148, 186, and 46,
accompanied by 57 breakdowns of 4+ week consolidations, and several close calls.
It will be significant to see if a further rally in stocks can bring new low
numbers below 20 again.
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, course “The Science of Trading,” and
new video seminar most of all, where I discuss many new techniques.
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 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
NH’s 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
(
CRA |
Quote |
Chart |
News |
PowerRating) @9.09 (8.35) w/ 8.9 ops; and short in:
(
BOW |
Quote |
Chart |
News |
PowerRating)
@37.5-now take profits on higher volume rally. 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 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.
Risks are high here,
so my suggestion continues to be to keep your powder dry. We still don’t know
if the Fed and other major central bankers will ease in time to prevent another
renewed market decline and further deflation globally. Japan has thrown in the
towel and announced a potentially massively inflationary policy. It is unclear
whether it will work or really be followed through with.
There is the increasing risk of war and substantial uncertainty of the
outcome of such a conflict. Will more of the Arab world join the fray? Will
Saddam set off a nuclear, biological or chemical weapon before he is ousted from
the world stage? What will be the effect if he does? Will the U.S. led forces
oust Saddam from power quickly enough to prevent him from doing damage via
weapons release, and will this restore faith in U.S. and global authorities or
is this yet the next step in an on-going war on terror that doesn’t have clear
enemies?
The Treasury department is now attacking hedge funds, one of the few bastions of
unregulated investment and one of the only investment themes that have potential
to profit in this uncertain environment. Will they cutoff growth and potential
in their new aim to try and put an identity on every dollar in the global
economy? And will they turn a free market system into a fascist centralized one
in the name of fighting money laundering? Investors are advised to wait and
watch carefully for a more reliable market environment.
Until then the potential gain from breakouts is not worth the risk, in my
opinion. Watch the breadth and leadership numbers the market gives off first and
primarily, and everything else secondarily. We will continue to try and navigate
these treacherous markets aiming for decent gains with relatively low-risk and
safety. Please stay tuned, now more than ever and emphasize the importance of
patience.
Mark