Traders Face 3 Questions In This Lopsided World

March 18, 2004
Mark Boucher

With
reflationary forces having peaked and now growth rates turning down
in China and the US, a deceleration in global growth rates is upon us, and the
markets are absorbing this change in scenario. Investors are uncertain about the
extent of the deceleration in growth and this uncertainty could last another 1-3
months or until clear signs of employment growth develop in the US.

Despite the most massive infusion of fiscal and monetary policy stimulus since
WWII globally, the dramatic swings in exchange rates accompanying this stimulus
have redistributed growth and stimulus among different nations differently. The
growth profile in the world is therefore quite lopsided, and this makes
visibility about the future less clear. On the one hand we have countries that
have intervened in their own currency markets as a form of stimulus â€” including
Japan, China, Mexico, and much of Asia. These countries to various degrees are
experiencing growth rates that are already starting or will eventually start to
trigger creeping inflation. Mexico has already begun to tighten policy to combat
rising inflationary pressures as has China, to a lesser degree.

On the other hand, many
countries are still experiencing recessionary or even deflationary forces, with
Europe being the worst case. An extremely strong euro has helped dampen what
little policy stimulus existed in Europe and has offset the growing export
demand from the rest of the worldâ€™s impact on Europe. Canada is now losing jobs,
the result again of an overly strong currency that tightened policy
prematurely. A strong peso in Chile is forcing the country into price deflation
and rates continue to drop. Australia and New Zealand had some of the strongest
economies in 2003, but huge currency appreciation combined with premature
tightening has led both these economies into a frightening pace of
weakening. Note that deflation- or recession-fighting countries all share a
sharply appreciated currency in 2003.

The US has had
massive monetary and fiscal policy stimulus unprecedented since WWII and it has
led to profit growth and very strong GDP growth for a couple of quarters, but
now growth is slowing and employment gains have yet to show up â€” and gains in
employment will be needed to make this recovery self-perpetuating.

Three
Questions

Is the world sliding back into
recession/deflation or is this just a deceleration of growth in an ongoing
recovery?

Is the last yearâ€™s rally in global stocks just a bear market rally
similar to the ones experienced in Japan after its bubble burst, that lasted
only as long as massive policy stimulus did but then died quickly after stimulus
receded?

Or is this just a normal correction in a cyclical recovery?

It is hard
to tell in this lopsided world, and that makes this period ahead more uncertain
than most. Investors should therefore maintain high cash levels until better
clarity appears.

Adding to the uncertainty is
terrorism. Al Qaeda just won its first election in Spain. Just a week before the
terrorist bombing, the incumbent Jose Maria Aznar, who supported the Bush
invasion of Iraq, was substantially ahead of Zapatero in the polls. Yet after
the bombing and Aznarâ€™s attempts to deny who was really behind the bombing and
pin the terrorist act on the ETA, Aznar lost the election. And Zapatero has lost
no time in making it clear that he will withdraw troops and not support Bushâ€™s
position, and has even gone as far as suggesting that the world will be better
off under a President Kerry.

Another brilliant attack by Al
Qaeda sympathizers has now changed the outcome of an election in a huge country
in Europe. With such success, it seems increasingly likely that terrorist acts
just ahead of elections in key countries will become more common, and perhaps
even policy of al Qaeda. Are elections of Blair and Bush the next targets?
Quite possibly.

In this environment investors
should stay cautious therefore as many uncertainties need to be ironed out
before a genuine new leg up is likely to develop. Wait for more evidence of
accumulation days in the major averages, and more broad-based breakouts in top
global themes. It would be nice to see recoveries in Thailand, India, Tech, and
other global leaders of last yearâ€™s bull move begin as well.

So far the strongest areas holding up to global market correction forces are
Japan (particularly small cap), Malaysia, Russia, selected energy, some resource
areas (base metals and oil in particular), silver and palladium, and real
estate. If we can get a couple good accumulation days in major averages and then
breakouts to the upside in these key leading areas, then investors could begin
to build some positions in these areas. But until then, letâ€™s mostly play
defense here. We continue to expect 2004 to be a volatile and risky year where
sector rotation and stock selection will be the keys to performance.

So far our US long/short model has been fully on the sidelines all year, and we
continue to suggest investors use some caution until stocks meeting our criteria
expand in breakout breadth. Investors should continue to cautiously add stock
exposure as trade signals are generated that meet our strict criteria, as well
as allocate to our favorite segments on breakouts and signals as advised above.
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) â€” 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 5, 7, 20, 11, and 28, with 8 breakouts of 4+ week ranges, no
valid trades and no close calls â€” weâ€™re back into trading range type of readings
once again. A trading range environment is likely until we get stronger internal
breadth numbers and higher quality and quantity of breakouts. Position in valid
4+ week trading range breakouts on stocks meeting our criteria or in close calls
that are in clearly leading industries, in a diversified fashion. This week, our
Bottom RS/EPS New Lows remained non-existent with readings of 6, 4, 9, 8, and 3,
with 5 breakdowns of 4+ week ranges, one valid trade in
(
TRMS |
Quote |
Chart |
News |
PowerRating) and no close
calls. The short-side breadth remains bleak and it will be important to see if
it picks up here on further corrective activity. We like semiconductor and
broad tech indexes as shorts against longs in our favorite groups.

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.

Until next week,

Mark Boucher

Traders Face 3 Questions In This Lopsided World

BUY THE FEAR, SELL THE GREED

Quick Links

Company Info

Contact

Company Resources