Trading Range Is Back
Well,
just when it was starting to look like a reasonable rally might be in
the offing, the market hit 1180 resistance on the S&P, right at the 200-day
moving average, and then made a Fibonacci time/price confluence that has started
a real correction. Actually, a retest of
the market lows made in September would in many ways be constructive.
That’s because declines off of a manic high similar to what we saw in
March 2000 have almost never tended to bottom off of a “V†bottom formation
(what we witnessed at the September lows).
The
1929 bear market TRIED to make a “V†bottom six
times, but each one failed until the July 1932 low was retested and made a
double bottom in 1933, eight months following the initial low. Breadth
improved and the market had a much better bull move off of this retest low.
Similarly, gold, Japan, even the 1973-75 U.S. market low also saw either
long trading ranges at the bottom or retests.
The
first sign of a retest would be a decline in the S&P below 1050. (The
current trading range is really 1050-1180.) A
move to the 1000 level or lower would constitute a retest in the S&P.
It is possible that the decline in confidence as exposure to accounting
problems mounts will allow for a retest to develop. Â
Recall
also that the typical breadth thrusts that we look for to initiate a new bull
market have not yet occurred off of the September market lows, and that
leadership has so far been sub-standard on this bull move.
If we could get some sort of confluence of breadth-thrust and leadership
improvement off of a subsequent low, it would be VERY
constructive for the market, and for the profitability of our strategies.
So, let’s watch for this carefully.
The
good news is that economically sensitive commodities still appear to be shifting
toward expecting recovery. Lumber, copper
and cotton are all at various stages in the base-building process, while bonds
are range-bound.AND nearby copper could move strongly above
the 75 level, AND nearby cotton could move strongly
above the 42.50 level, AND nearby bonds fall on
good volume below the 98 level. Only one of these has occurred. Lumber gapped up
through the 275 level, and is now pulling back.We
also recommend keeping an eye on commodity currencies, as they also hold clues
to the health of the economy. The Aussie
dollar and New Zealand dollar remain in tight ranges as they build bases; watch
for the AUD to move above .55 or below .48, and the NZD for a move above .46 or
below .39 to confirm the recovery/recession scenario.
The Canadian dollar, another economically sensitive currency, broke to
new lows last week, but quickly gapped back up into its own trading range.
For
now, breadth numbers have returned to trading range indicative, directionless
undertones. There have not been many
opportunities coming across in quality stocks that are in leading sectors with
favorable growth prospects. We will
continue to keep the big picture in sight and take a top-down approach, paying
special attention to group relative strength. This is very important in a market
that may see a recovery that is disproportionately smaller than what we have
become accustomed to.
The
breadth and leadership numbers for this week shifted further to slight downside
dominance for the first time since the September lows, but we are still a long
way from seeing the type of sharp downward expansion we would need in order to
significantly increase short-side allocation. Top
RS/EPS New Highs went back to lackluster this week (38, 23, 11, 10, 24), and
breakouts were few and far between. Bottom
RS/EPS New Lows accelerated throughout the week (6, 9, 21, 40, 37), but
still could not push above 20 per day consistently.
Look
for Top RS/EPS New Highs to not only reach 20 or higher CONSISTENTLY
in a week, but also 100+ on at least one day or 50+ on two or more days before
becoming very bullish; or conversely for Bottom RS/EPS New Lows to reach 20+
consistently with a couple days over 50 or a day over 100 before becoming very
bearish. Breakouts vs. breakdowns of four-plus-week consolidations on our lists
for the week remain low, totaling 13 breakouts vs. 23 breakdowns, but with no
real close calls on either side. Opportunities
thus remain very scarce for highly reliable trades.
Our
overall allocation remains DEFENSIVE with 92% 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 — all on a
worst drawdown of around 12%. We’re now down about 0.14% for the year
2002.
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 subgroup 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). We’ve been
effectively defensive ever since.
Upside
breakouts meeting up-fuel criteria (and still open positions) so far this year
are: Ryland Group
(
RYL |
Quote |
Chart |
News |
PowerRating) @64.3 (77.04) w/72.30 ops; and Direct Focus
(
DFXI |
Quote |
Chart |
News |
PowerRating) @35.09 — out (31.45) on 31.5 ops. 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 until we get
breakouts in the S&P and Dow.Â
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.
We
continue to advise caution and patience until the market takes a more decisive
stance. We all know that the market can
get ahead of itself, so it is best to wait for confirmation that we are seeing
real economic recovery.