Still Need Leadership, Global Market Confirmation
The
situation remains very similar to that reported last week.
We had a couple 9/1 up-volume/down-volume up thrusts in July, the first
breadth thrusts since the March 2000 market peak.
And we’ve had decent volume action in general, with more follow-through
days on the upside than distribution days, and with volume following off some on
most declines. The 7/24 low came off of
the most oversold and overdone sentiment the market has seen in this bear
market. And the structure of the decline
along with technical and seasonal analysis would lead us to suspect that the
initial wave of this bear market would likely be over sometime this late summer
to fall and that a bear rally of greater magnitude than any since 2000 would
develop.
However, breadth in terms of
advances and declines, breadth in terms of foreign market participation, and
breadth of valid breakouts of sound four-plus-week basing patterns and
consolidations are still far too scarce for us to get overly excited about this
market environment yet. Breadth of new
highs on our Top RS/EPS New High lists has fallen back, and most significantly,
there remains no clear leadership emerging yet (other than the already strong
regional banks and S&Ls which are not discounting economic growth, but
continued wide yield curve spreads).
Non-equity market messages are
not clear yet either. Global bond prices
have reacted off of lows from last week, but are not yet clearly trending lower.
Corporate yield spreads have come down slightly, but still remain at
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.)
Asian markets, which usually
lead in a global economic recovery, have moved up only grudgingly since July
lows. And commodity prices have not
recovered consistently as we would expect in a global recovery, despite oil
prices rallying due not to stronger demand, but in response to low inventories
and war talk. Only the recent breakout of
a head-and-shoulders reaction low in the Australian dollar appears to be looking
toward recovery in the global currency markets, where the dollar’s correction
has hit a snag.Â
Thus the combination of
tentative market signals, poor clarity in non-equity market signals, and poor
leadership lead us to remain very cautious with respect to both the long and the
short side of the U.S. equity market. If
leadership and broader breakout participation can develop, then this rally may
develop into something nicer than investors have seen for nearly two years.Adding caution to our reading
of the market is the revving up of the engine of war.
Attendees of the Crawford meeting of Bush’s war council last week
admitted to intelligence sources that Bush preferred to invade Iraq sometime
between September 9 and the end of October. While
Bush’s desire doesn’t necessarily mean this will happen, this is so soon and
potentially volatile an event, that we believe it’s wise to display extra
caution unless pulled from doing so by clear market action.Â
Continue to watch for another
breadth like 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. So
far the market is able to rally some on slightly negative news.
Continue to watch for this. A
rising market despite coming potential negative news on the earnings or economic
front would be a strong indication that this rally has more to go.Â
Realize too that global markets
are still discounting more rate cuts ahead. Concerted
global monetary stimulus would be a real plus for the market rally to gain
ground in the intermediate-term. Whether
rate cuts will work to solve economic problems long-term is another question,
however. And as rate cuts have not yet
been forthcoming, investors must also be on the watch for the threat of
deflation and renewed economic weakness getting out of hand to the point that
rate cuts are too late. If deflation
develops, monetary policy will be less and less effective.Â
Our strategy remains ultra
defensive, but continues to slug out small gains.Â
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 under-performing 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.Â
Top
RS/EPS New Highs fell back sharply this
week and still have not mustered one solid week of consistent +20 or higher
readings, which is disappointing. Readings
this week fell back to 21, 10, 15, 15 and 4, with an astonishingly pathetic one
breakout of a four-plus-week consolidation pattern. Bottom
RS/EPS New Lows remain at low levels too, with readings of 1, 7, 9, 12 and
21, accompanied by just three breakdowns of four-plus-week consolidations.
Remain heavily on the sidelines until the environment improves and
opportunity breakouts of close-calls become more abundant.Â
Our official model portfolio
overall allocation remains TOTALLY DEFENSIVE. We’re
now 100% in T-bills (including short sale proceeds) 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 5.27% for the year 2002. Let’s
wait for a bit better environment before positioning heavily.
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 NONE.
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 market volatility is more
normalized.
The Fed seems to think that the
economy may have enough momentum to continue growing slowly without
intervention, but is ready to step on the gas again if economic statistics start
to drift lower again. Global central
banks have all shifted toward an easing bias, but few have yet eased.
If the economy does drop further, will they cut quickly and strongly
enough to prevent a return to recession? And
if it doesn’t move lower, how long will we have to rate for growth to pick up
to a pace that will send earnings and revenue growth to higher levels?
If Bush does invade Iraq,
he’ll probably have about two to three weeks to show apparent victory before
the market reaction is negative. All
these questions add risk, and risk is what we try to avoid unless we have a
clear advantage in these dynamic global markets.
Continue to watch global bonds,
global stocks, and global commodities closely, as this may be the most important
period in your economic lifetime directly ahead.
A renewed crash by stocks, rally by bonds, and decline to new lows in
commodities will likely signal not just global recession re-emerging, but global
deflation for a very long time. 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.