Stay Selective: Leadership Fading Or Shifting

  • July 7, 2000
  • Mark Boucher

Last
week (Wednesday through Wednesday) brought us two downside breakouts
that were close to meeting our downfuel criteria and one upside breakout in a
stock almost meeting our criteria, with no new trades.  
Neither the Top RS and EPS New Highs
list nor the Bottom RS/EPS New Lows
list
showed consistently more than 20 issues last week, signaling that it is not a
great environment for either our short or long strategy. Similarly, when Bottom RS/EPS New Lows top 20 daily and we get handfuls of stocks meeting or almost meeting
our downfuel criteria and breaking down out of valid patterns each day, then it
will be safe to get aggressive on the short side.
Until then, remain selective and somewhat cautious.




The
earnings pre-announcement season is upon us, and it has started to show the
slowdown in economic strength in some tech stocks. Oracle
(
ORCL |
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Chart |
News |
PowerRating), Electronic Data Systems
(
EDS |
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Chart |
News |
PowerRating), Computer Associates
International
(
CA |
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Chart |
News |
PowerRating) and others all reported significantly
lower earnings than expected and this hit the market hard on Wednesday. Some analysts have lowered their expectations for the mighty
semiconductor industry — and semis took it on the chin big time. Nearly half of the breakouts since May have been in the semiconductor
industry or related industries, and if these leaders are going to start to fall
significantly, it will not bode well for the market. Watch a
Nasdaq decline below 3690 on good volume as an early warning
signal that this rally is in real trouble. Until then, we’ll assume that the rally is intact and we’ll watch for
either a quick recovery in semis or a clear transition to new leadership to
develop — perhaps in biotech.




This
week Hall Kinion
(
HAKI |
Quote |
Chart |
News |
PowerRating) broke out and met all our criteria, but was not in a leading group on
the upside. Tenneco Automotive
(
TEN |
Quote |
Chart |
News |
PowerRating) broke down but had
no downside potential with a PE of 3, while Wausau-Mosinee Paper
(
WMO |
Quote |
Chart |
News |
PowerRating) had an iffy pattern, but met
downfuel criteria. We took small
profits on Rhythms Netconnections
(
RTHM |
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Chart |
News |
PowerRating) on trailing stops this week on the short-side. Selective investors stood aside, as none of these met all of our strict
criteria for entering a trade. Remain
selective.




Our
overall allocation remains low. We
are now around 50% long (including open profits) and 7% short for aggressive
accounts using leverage (25% long and 3% short for unleveraged, more
conservative accounts). Last week,
our longs gained an average of 3.7% (and with 50% allocation starting the week
this added 1.85% to our overall portfolio on the week), while our shorts rose an
average of 5% (and with 14% allocation this subtracted 0.7% from our overall
portfolio), giving our overall portfolio a gain of about 1.15% on the week, and
leaving us with around a 73.5% gain on the year (another new equity high) on a
12% maximum drawdown so far. Conservative
investors not using leverage show about half these gains and drawdowns.




For
those not familiar with our long/short strategies, we suggest you review my 10-week
trading course on TradingMarkets.com. 
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+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 could stop at
50% long and 50% short). In early
March, 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. Remember that while breakouts don’t start en masse until the trend has
already started, they make up for lost time because the stocks that break out
move much more swiftly than the rest of the market. That’s why our long
positions have outperformed so strongly on the upside and our short positions
have outperformed so strongly on the downside as well this year.




Upside
breakouts meeting fuel criteria (and still open positions) so far this year are: Key Production
(
KP |
Quote |
Chart |
News |
PowerRating) (@13.38 level) w/ 15.25 ops; PC Connection
(
PCCC |
Quote |
Chart |
News |
PowerRating) (@26.46) (half profits
taken) w/ 49.25 ops;  Alliance Capital
(
AC |
Quote |
Chart |
News |
PowerRating)
(@44) w/ 44.5 ops;  Keithley Instruments
(
KEI |
Quote |
Chart |
News |
PowerRating) @37
— (those in full sync with our strategies should have taken profit on a move
below Wednesday’s high volume reversal low; for the record we’ll use 70 ops on
1/2 position and  62.5 ops on 1/2); and
Elantec Semiconductor
(
ELNT |
Quote |
Chart |
News |
PowerRating) @50.25 w/ 51 ops; (Note that because we now have
break-even stops on all our positions we can now add any new breakouts in any of
these groups that meet our criteria) and this last week we had no valid
pattern breakouts up in stocks meeting our up-fuel criteria (see 10 week trading
course): The average gain
in these stocks from breakout points of entry to Wednesday’s close is 70%,
substantially outperforming the Nasdaq, Dow, and S&P for the year to date. Continue to watch our
NH list and buy flags or cup-and-handle breakouts
in NHs meeting our up fuel criteria.


 




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:  Rhythms
Netconnections
(
RTHM |
Quote |
Chart |
News |
PowerRating)
(@16.56) — out on 14.5 trailing stop to lock in profits; Ciber
[CBR|CBR] 
@13.44 now use 15
ops. These shorts are down
over 33% from breakdown levels on average so far this year (before
current prices or exits). 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. 


 




The
trend of the market is not yet fully clear. The buy-side has been looking better than the short side, but further
steep declines in the new leaders next week would be cause for serious concern. I
also hope that this week’s late action and weakness in the semiconductors is a
valuable lesson in the power of diversification for investors. Those who bought breakouts regardless of industry were loaded up with
semiconductors (which made up more than half of all breakouts by our count), and
they took big drawdown hits late this week. Those who spread their bets among different industries (as per our money-management rules) have profited nicely from this rally and have not taken a huge
hit. Watch Nasdaq 3490 and Dow
10,300 on the downside — and get more defensive if both these levels give way. 
I continue to be happy with the allocation indicated by a religious
application of our strategy. So far,
it is doing a great job of telling us what to do, 
when, and with how much allocation. Let’s stick with it and see if the market can prove this rally better
with higher quality breakouts and if leadership can re-emerge.