The Seas Are Getting Choppy–Here’s Why

• March 14, 2005
• Mark Boucher

As Fed
tightening and inflationary pressures begin to take a toll on bonds,
global stock markets are likely to become more difficult and choppy in the weeks
and months ahead.

Let’s look at the significant
levels we discussed last week.  The dollar clearly broke down in the face of
continued announcements by foreign central banks of a desire to diversify
reserves.  Tomorrow’s trade report will likely have an effect on the dollar
traders should monitor as well.  While we do not think a substantial move in the
dollar is in the cards when it now has a yield advantage over many other
currencies, for now the trend is down and continuing and we shouldn’t fight it. 
Gold, the free-market currency has confirmed the move.   Should the dollar break
down below 78 and gold break to new highs quickly, that would set commodities up
to boom in a way that would signal inflationary pressures.  A confirming move
down by bonds would signal trouble for stocks quickly.

Oil has retested the WTI highs
and backed off with a sound reversal.  OIH has tested the 100 level and
reversed, and XLE has had a huge outside day down and follow-through down day on
strong volume.  We therefore advise taking some profits on oil and energy shares
here.  The trend is up and it is strong, but we would feel safer adding back on
a correction or after new highs are clearly made in oils and oil indexes.   A
brief spout of weakness in oil and oil shares would be a positive influence on
equity markets.

10-year bonds broke down, but
the 30 year nearby futures merely tested the support we were monitoring at 110. 
A break down by June bonds below 110 will be very bearish for bonds, and put
pressure on stock prices quickly.  This one is unresolved so far.

 

^next^

Equities likewise have not
signaled a complete breakout or breakdown.  SPY over 124 and DIA over 110 would
signal a likely further move higher, whereas SPY under 118 and DIA under 106
would be the first signal to move to an even more defensive posture.

Sometimes it is better to
mostly watch a fight than to participate in it much.  That may be the case to a
large extent in the current market environment.  Risk is rising. We suggest
investors continue to watch carefully and go with CLEAR decisions by the verdict
of the markets for their short-term trading endeavors.

In US and global equity
markets, value/growth appears to be working and logical whether the market moves
up in a late phase rally, makes a volatile top over months to years, or even
moves down as the softness takes hold later on.  European financials and
European financials/US financials continue to do well.  Commodities have broken
out and may run as the CRB sets up a potential test of the 340 level, but this
could be a quick move to end and investors should tread carefully.  More neutral
long/short strategies that buy the strongest sectors like energy, managed care,
soft drinks, foods, staples, rails, and short weaker sectors like financials,
brewers, US autos, airlines, and parts of the technology sector — also seems a
good profit generator, albeit with some volatility, in this new era.  Investors
should adopt a much more equity defensive and negative market stance if US bonds
breakdown or oil clearly breaks out. 

Our model portfolio followed in TradingMarkets.com with specific entry/exit/ops
levels from 1999 through May of 2003 was up 41% in 1999, 82% in 2000, 16.5% in
2001, 7.58% in 2002, and we stopped specific recommendations up around 5% in May
2003 (strict following of our US only methodologies should have had portfolios
up 17% for the year 2003) — all on worst drawdown of under 7%.   This did not
include our foreign stock recommendations that had spectacular performance in
2003. 

This week in our Top RS/EPS New Highs list published on TradingMarkets.com, we
had readings of 86, 169, 177, 79, and 62 with 24 breakouts of 4+ week ranges, no
valid trades and  close calls in NSC and DXYN.  This week, our bottom RS/EPS New
Lows recorded readings of 11, 18, 16, 12, and 20 with 6 breakdowns of a 4+ week
ranges, no valid trades and one close call in UIS.  Valid signals remain in
place in MLI, BHP, USAP, LCAV, and JBLU.    The balance of longs and shorts and
breadth in top RS NH’s versus bottom RS NL’s is slightly positive but drifting
lower this week.

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.

Mark Boucher