Terrorist Disaster Will Likely Lead To New Lows And Recession Risks
In
the aftermath of the terrorist attack on the World Trade Center and Pentagon,
most European markets have gapped down between 5%-10% and staged minor
recoveries. Therefore, we would expect a
gap down when the U.S. markets open of 3%-10% initially — which may well be
enough to force even the Dow to new bear market lows (breaking the March lows).
This initiates a new bear leg down. The
risk of recession has now increased markedly, and the likelihood of early
recovery has been aborted. Investors need
to watch carefully for how much consumer sentiment falls after the markets open
— it will be a key component of how bad the long-term affects of this calamity
will be.
The
bright spot is that global rates are likely to fall much farther and faster
after the terrorist attack than before it, despite the ECB’s holding steady on
rates today. The fighting of fear by
central banks increases the likelihood of a deeper market reaction in the
short-run but with a V-bottom, as aggressive stimulating becomes much more
likely.Â
It
is too soon to grasp the full-scale of implications from the terrorist attack or
from the “War on Terrorism” that is likely to follow.
We will watch the news and the markets’ reaction to it carefully and make
reasoned judgments whenever we can.
We
will look more carefully at breadth numbers and economically sensitive
commodities in next week’s commentary, after markets have opened and we have
some real data to assess.
Our
overall allocation is now DEFENSIVE with 68% 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 10.3%, with a heavy cash position.Â
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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 on
leading or lagging industries according to our group and sub-group new high and
new 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.
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 continue to add just two per week and only in leading
groups.
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: Global Crossing
(
GX |
Quote |
Chart |
News |
PowerRating) @6.05 (3.78) — now use 4.45 ops; Phelps Dodge
(
PD |
Quote |
Chart |
News |
PowerRating) @38.1 (36.33) — now use 40.5 ops; Brasil Telecom
(
BRP |
Quote |
Chart |
News |
PowerRating)
@31.69 (25.3) w/30 ops; and SBA Communications
(
SBAC |
Quote |
Chart |
News |
PowerRating) @12 (11.86) w/14 ops. 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. And don’t double up on any industry until you have
a breakeven or better ops in any other short issue in the same industry.
After
Pearl Harbor, the market sank, rallied a bit, and then kept heading lower for
another 13 weeks or so. After
Eisenhower’s heart attack, the market gapped down, rallied for a few weeks, and
then retreated to new lows over the next 11 weeks.
When JFK was shot, the market dropped 5% quickly, but this marked the low
point and a strong rally developed thereafter. In
this situation, we would guess that the markets will again gap down and then
recover some, but then need more time to assess the damage, and likely retest or
break to new lows at least over the next 10-20 weeks until solid evidence of
recovery begins to emerge. But let’s not
look around too many corners.
As
we’ve mentioned before, negative surprises of all kinds develop during bear
markets. That,
along with a very small number of opportunities on the long or short side, has
kept us heavily on the sidelines since March of 2000, eking out reasonable, but
not very exciting gains. But grinding out
small gains beats the pants off of getting whipsawed back and forth and losing
money trading when the odds are not clearly in our favor or being heavily
allocated during potential shocks. It is
amazing how nature picks on the weak. Lions
hunt for the slowest and weakest of the pack to eat.
Shocks like terror, war, even natural disasters, tend to develop more
frequently during economic downturns and bear markets than when the markets are
overexuberant. America and global
capitalism will overcome this disaster just as it has much worse disasters
throughout American history. Economies
will ebb and flow, but head higher over the long-term as mankind’s progress
marches forward. But we suggest patience
and caution in the short-term until we can better assess how to find
opportunities in this new era that is now upon us.There
are ten people that I knew who appear to have been lost in the incredible
catastrophe. To any of those who also
lost friends or family or loved ones, our heartfelt condolences and sympathy
goes out to them. This is an incredible
shock, and further pops the cultural bubble of American invincibility that
prevailed here. But there is no system
and no people who can better adapt, change and overcome than capitalism and the
American people. And there is no
mechanism that can enable mankind to adapt and grow into any circumstances
better than free markets. The markets
will re-open and the world will overcome this disaster.
This is not a time for panic, but for reasoned judgment and gratitude for
the incredibly resilient system that freedom has developed.