The Disinflation Balancing Act
Right
now global markets are enjoying disinflation. Inflation perked up in
the first quarter and has now fallen off. Chinese inflation is on the decline
and export prices are falling. European inflation is melting while Japan is back
in deflation. Even inflationary pressures in the US show signs of easing via
declining ISM manufacturing prices paid. Global bonds, and to a much lesser
extent, stocks, are rallying on the disinflation story and the prospect for an
end to Fed rate hikes after the next one or two Fed meetings. However lower
growth likely means lower profits as well, though the market is not focusing on
this now. Yet if disinflation, which allows inflation and interest rates to drop
while stocks crawl higher, can continue for the rest of the year, the rally may
improve in quality. Disinflation in this global climate though, is a balancing
act. The trick is for disinflation not to feed lower profits or to grow into
deflation where stocks will decline whether bonds rally or not, or to filter
back into higher inflation via higher commodities, oil and dollar prices.
Deflation happens when pricing power turns negative. Profits growth will take a
hit with higher oil prices or too much higher a dollar. It is a precarious
balance investors need to watch carefully.
The dollar continues strong.
Commodities appear to be in a trading range — although weather scares in the
grain belt and further lack of rains may influence this. Oil is retesting its
highs, which is negative for the market, but looks also to be in an established
range. Bonds continue in strong move globally. It is a unique environment, and
we continue to believe that investors should treat it more cautiously than
normal. If more breakouts develop and the rally turns into a new bull leg, a
host of stocks meeting our criteria will breakout with more plurality in the
weeks ahead — and those will be the ones to buy.Â
This week in our Top RS/EPS New Highs list published on TradingMarkets.com, we
had readings of 94, 84, 86, 136, and 57 with 29 breakouts of 4+ week ranges, no
valid trades and no close calls. This week, our bottom RS/EPS New Lows recorded
readings of 4, 10, 14, 13, and 17 with 7 breakdowns of 4+ week ranges, no valid
trades and one close call in AMLN. Valid signals remain in place in LCAV on the
long side and none on the short-side. Broadening strength in our Top RS/EPS new
highs will lead us to venture slightly more on the long side if the rally
continues to build breadth.
For those not familiar with our long/short strategies, we suggest
you review my book
The Hedge Fund Edge, my course “The
Science of Trading,”
my video seminar, where I discuss many
new techniques, and my latest educational product, the
interactive training  module.
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 long 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 of change in the
new-economy/old-economy theme appeared to be upon us. We’ve been effectively
defensive ever since, and did not get to a fully allocated long exposure even
during the 2003 rally.
My advice remains: Tread lightly and carry a big wad of cash
awaiting a better odds environment. A softlanding later this quarter could set
the stage for some fantastic opportunities down the road a ways.
Mark Boucher