Retest Potentially Completed

• July 20, 2001
• Mark Boucher

No
sooner did all three indexes break their respective trading ranges to
the downside, than breadth started to improve on the bullish side.
Such is this wicked trading-range market — technical patterns that are
usually reliable are not completed and the market is whipsawing traders back and
forth. With the pre-earnings season out
of the way, the market is usually able to display a “sell the pre-earnings,
buy the earnings announcements” mentality. It
is possible that last Wednesday’s lows in the indexes WAS the retest of the
lows. Now we will need some more follow-through
days and evidence of breadth entering the market on the bullish side.
Remember what we’re looking for in terms of breadth-thrusts to tell us if
a likely strong and sustained bullish move is in the making:

Look
for two or more of the following clues to a real upside reversal before
considering any strong allocation to the longside in the weeks and months ahead: 
1) Up-volume being 77% of total volume on at least one strong volume up-day;
2) 3)
Some sort of financial shock or necessary bailout that will end the
liquidity squeeze currently under way in Europe;
4) At least one O’Neil follow-through day (a major index has prices up 1%
or more on higher volume than the prior day) where volume is much stronger than
the average volume of the last 50 days; 5)
Clear evidence that the economy is picking up significantly by several reports;
6) most importantly, look for a broadening of our Top RS/EPS New Highs
list to above 20 names for several days in a row (and a strong market should
exhibit above 50 for a week with a couple days above 100), along with some clear
group leadership in breakouts of stocks on this list, and a handful of new
breakouts of four-plus-week flags or cup-and-handles in stocks clearly meeting
our “up-fuel” criteria (see my 10-week trading course on
TradingMarkets.com). Until we get many of
these events coming together, I suggest investors beware of this market and hold
back on any significant increase in allocation to the longside.
Sure, there are likely to be very sharp bear market rallies at any time,
but until we get solid evidence that there’s something real behind them, they
are likely to lack the follow-through we need to make decent profits.  

Economically
sensitive commodities:  Copper and cotton
made new lows this week again, lumber is
a volatile mess, and bonds broke out to
the upside. That’s three out of four
commodities telling us the recovery is not yet even anticipated in the economy.
Maybe this is why Greenspan is still not expecting any blip in the
economy until next year. This raises the
specter of another tough earnings period once third quarter anticipated numbers
begin to be talked about, prolonging the whipsaw trading-range environment.
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
still has a slight bullish bias which actually improved quite significantly in
the latest week. New
Highs vs. New Lows on our RS/EPS lists were
23/16, 29/10, 34/15, 30/12 and 43/16 — new highs above 20 consistently all
week, regaining dominance. 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. There
were 21 breakouts on the upside to new highs of stocks on our Top RS/EPS
New Highs list with some close calls —
(
LEN |
Quote |
Chart |
News |
PowerRating) and
(
FRX |
Quote |
Chart |
News |
PowerRating) — and on valid
buy signal in Doral Financial
(
DORL |
Quote |
Chart |
News |
PowerRating), and a dismal eight breakdowns on the downside of
four-week-plus consolidations on our Bottom RS/EPS New Lows list, with no close calls.
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, but slightly biased to the
longside.

Our
overall allocation is now in SUPER DEFENSE with 92% 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 3.77%.
Note that we DID manage to make a little money on the rally off of the
April lows, thanks to low allocation, good stock selection and tight stops.
It helped that we knew that breadth was poor and that this rally was not
likely to materialize into something lasting — information we learned from
watching the breadth-thrust indicators listed above, as well as watching the
breadth and group action on our Top RS New Highs lists.
It pays to pay attention! 

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
w/31.75 ops. We managed to book profits on
three of our four longs since the April lows and we actually made a little bit
of money on our overall portfolio — but it wasn’t fun or easy, folks.
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: no open positions.
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.

DORL
barely met our criteria. Although it did
meet our fuel criteria:  GR 28%,
last quarter up 33%, this quarter up 41%, with momentum in both earnings and
earnings growth; PE/GR <70; Cup-and-handle
breakout on a thrust pattern with volume over 50-day MA of volume (but not
substantially higher than other days, making this questionable volume-wise).
Funds and banks below 30 and debt 0. The
reason DORL was questionable was its group ranking.
S&L’s and banks HAVE been among the top groups appearing on OUR Top
RS New High Group ranks for weeks, which is why we took this trade, but on IBD‘s
list of new highs, S&L’s don’t rank in the top 40, although two similar
banking groups do. A marginal trade at
best, but meets our criteria.

Let’s
see if we can’t get some breadth-thrust indications of a better market
environment. Patience is a pain, but in
this environment, it’s not nearly as expensive as getting whipsawed, which is
what’s happening to most market participants in this environment.
Remember that it only takes a couple weeks of good environment to make a
year’s worth of profits in these markets. Wait
for a good shot before shooting with significant allocation!