Taking A Breather

March 15, 2002
Mark Boucher

The
market took a breather this week, digesting its recent gains. Both
the S&P and Bonds simultaneously hit key
Fibonacci levels on Fibonacci dates, so this may initiate a real correction that
will last longer than days. Not only is
this natural after an explosive rally, but it is also necessary. We donâ€™t want
the market to run away from us because then higher prices become unsustainable.
We would rather see a series of rallies on volume followed by pullbacks on
lighter volume to be convinced the rally is meaningful. So, despite the return
to lackluster breadth numbers, the marketâ€™s action this week is actually
encouraging because the consolidation is occurring on decreasing volume. The
positive follow-through last week still counts as a breadth thrust, and we will
be keeping our eye out for a 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 to make this a totally confirmed
bull move.

As
the market continues in its reparative phase, we will focus on the
intermediate-term trend and use that knowledge to position our model portfolio
to take advantage of groups showing relative strength. The market DID correct
enough to be considered a retest, but the breadth numbers reveal that there is
still a lot of work to be done. The Nasdaq is finally moving more in sync with
the broader market, so investors should feel less averse to technology stocks
and try their best to identify emerging trends. Read the paper between the
lines, know the companies behind the stocks, and watch for
base-breakouts!

The
market is still positive enough for me to allow more than two stocks a week to
be added to the long side â€” but we may not get such positive action for a
while. Watch the strength of this global
rally carefully to see if it holds up again on this correction â€” Asia (x
Japan), Eastern Europe, Latin America, global small cap value, and U.S. small
cap value, along with Junk bonds and Emerging Market Debt.Â

Outside
the U.S., a broad plurality of markets are now giving the all-clear signal. Most
global markets we follow, developed and emerging, have crossed above their
200-day moving averages or are very close. The interest rate environment is
falling into place, and commodities are rallying.Australian and New
Zealand dollar are very close to breaking out of their ranges on the
upside. When cotton,
copper, the New Zealand dollar, and the
Australian dollar have all broken out of their ranges, weâ€™ll really have a
plurality of markets telling us the global recovery is underway.
Lumber is already singing recovery.
All of this suggests that the global recession has lost its hold.

We
have been exposed to areas such as Emerging Asia (x Japan) and Eastern Europe,
as they have been the leaders going into this recovery. Now it makes sense to
broaden exposure to Latin American markets and very lightly on this correction
add some developed European nations (in the small cap value sector).
Bonds are heading lower to test support, but like the S&P, in the
short run theyâ€™ve hit Fibonacci support in a Fibonacci time zone, so they
could bounce a bit before breaking down. Look
for a potential breakdown through the bottom-end of its range at 98, which, like
copper and cotton breaking out, would confirm the global recovery scenario.

Remember
that the U.S. market is only likely to correct 50%-68% from here to its 2000
peak levels â€” not make a new high. So
far this looks and acts like a mini-bull market, a la 1972-1982, not like the
secular bull moves since 1982. In
addition, most U.S. equities are extremely overvalued, as are most European
markets (though not as much as the U.S.).

The
value and the real bull move is in Emerging Markets, not developed ones. Aggressive
investors should emphasize Asia, Eastern Europe, and Latin America, Junk Bonds,
and Emerging Market Debt, along with global small caps with probably about half
their portfolios. Right now, this is
where the action and potential are.

Even
though on a macro viewpoint the U.S. is not the place to be, we still think that
our long/short strategy in growth stocks with decent value will be able to show
good returns this year. But realize the
U.S. market is likely to be volatile, and our approach will not be able to avoid
some of that volatility. I would be
surprised if we didnâ€™t have a bigger drawdown than weâ€™ve had since
TradingMarkets.com launched this portfolio, though, of course, weâ€™ll try to
keep risk very low. This week we were
able to add more than two stocks for the first time since early 2000.
Once this mini-correction has run its course, we would expect more
opportunities to develop. Wait for them
before increasing exposure – and ONLY in leading industries!CRB Index
(CRBFCOMP on Bloomberg).

With
commodity prices moving off their bases, economically sensitive currencies
showing strength, and global bonds heading lower, we changed our posture to
slightly more bullish in our model portfolio intra-week, allowing the addition
of more then two names per week in leading industries.

Top
RS/EPS New Highs totaled about half of what they did last week (40, 29, 25,
24, 21). Still, reaching 20 or more per day consistently is better than we have
seen in the past. Breakout numbers were pathetic, with only 12 breakouts for the
week, but the quality of the breakouts improved, and we were able to add four
stocks to our model portfolio: Garan
(
GAN |
Quote |
Chart |
News |
PowerRating), Crown Group
(
CNGR |
Quote |
Chart |
News |
PowerRating), Lands’
End
(
LE |
Quote |
Chart |
News |
PowerRating) and Coventry Health Care
(
CVH |
Quote |
Chart |
News |
PowerRating). Bottom
RS/EPS New Lows were almost non-existent this week, with just 12 total and
only four real breakdowns out of valid flag patterns or cup and handles of more
than four weeks. The important thing to note is that the ratio of New Highs to
New Lows is more than 11:1. This is characteristic of a market that is
positively biased, and investors should be poised to take advantage of breakouts
when they do become more plentiful.

NEW
HIGHS VS. NEW LOWS

Our
overall allocation remains SOMEWHAT DEFENSIVE with 52% 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 â€” all on a worst drawdown of
around 12%. Weâ€™re now up about 2.83% for the year 2002, and we will stick
with the winners like Ryland Group
(
RYL |
Quote |
Chart |
News |
PowerRating) and American Woodmark [AMWD|AMWD]
and let them run.

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
an environment unclear directionally, we also 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.

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.

With
a broad plurality of messages supporting the global recovery scenario, investors
should become less defensive. If the market continues to repair itself by stair
stepping higher, itâ€™s about the best thing we could ask in an environment
where corporate profits are on the mend and as the War on Terrorism presses on
in the wake of the six-month anniversary of Sep. 11.

Taking A Breather

BUY THE FEAR, SELL THE GREED

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