Trading Range Still Unconvincing In Any Direction
It
would be nice if the Fed rate cuts would lead to a more convincing
rally, but at least so far, no such luck. The
trading range now appears to have a slight upward bias — but two distribution
days down the road and that will change. Neither
direction of movement is accompanied by convincing breadth right now, so the
trading range continues to grind on. Therefore,
we suspect that any rally or retest is part of an ongoing trading range that may
develop into an A-B-C type of multi-week bear market rally. Investors
should note carefully that the breadth indicators mentioned in many of these
columns since Sept. 21 have yet to flash two or more up signals. This leads us to suspect that the market is not yet embarking on a
sustainable uptrend.
As
we’ve been commenting since the Sept. 21 low, the most important aspect of the
market, leadership, is still lacking. Until
we get a lot of valid breakouts of four-plus-week consolidations (flags or
cup-and-handles) of up-fuel stocks and/or close calls that are making our Top
RS/EPS New Highs list in leading groups, then and
only then will we
begin steadily increasing our allocation to the long side.Bottom
RS/EPS New Lows list in lagging groups, then and
only then will we
begin steadily increasing our allocation to the short side.
Let’s
look at the breadth numbers on our lists for the week.
Top RS/EPS New Highs vs. Bottom RS/EPS New Lows for the latest week were
12/11, 6/8, 15/3, 21/10 and 16/8. Things
are slightly improving on the upside, but breadth remains clearly trading-range
indicative — with no clear dominance by shorts or longs and neither showing 20
or higher consistently on the week. Breakouts
vs. breakdowns of four-plus-week consolidations on our lists for the week were
0/2, 2/1, 3/0, 6/3 and 2/1. There was a
close call long and a close call short, but no solid trades on the week.
Breakout numbers remain pathetic, as the market is not yet clear which
way it’s heading.
Economically
sensitive commodities remain clearly bearish. Copper
and lumber made new lows this week, while bonds made new highs.
Only cotton is undergoing any kind of minor rally at all.
Therefore, commodities are thus still clearly discounting recession —
with no recovery in sight. We continue to
suspect that a sustainable rally in stocks will not develop until we get
clear bottom formations and upside breakouts in copper, lumber and cotton, and
U.S. bonds begin to top out and break down.
Our
overall allocation is now super defensive with 100% in T-bills awaiting
new opportunities. Investors wanting a
bit better yield with some slight upside potential may want to look into
top-grade corporate bond funds with most of their cash — these are yielding
6.5%-7.5% and offer some small appreciation potential while we wait for
opportunities (total return potential looks like 10%-12% annualized).
Avoid funds that are not investment grade and that have loads or exit
fees. 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 the year 2001, we are now up
about 12.75% with a full cash position.
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 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. We’ve been
effectively defensive ever since.
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 NHs meeting our up-fuel criteria — but continue to add just two per week,
and only in leading groups. If we get
two or more of the above breadth criteria for the overall market developing from
here on, we’ll then drop the “two per week only” advice on longs —
but until that develops, let’s remain somewhat cautious.
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.
The oversold nature of the market leads us to suggest that investors remain
cautious by only adding two shorts in a week.
While
the market is rallying weakly, I would still suspect that an eventual retest
will develop sometime in the next 20 weeks in the absence of solid evidence of
recovery. Continue to let the market show
us with breadth and then leadership measures if a really playable rally or
playable decline can materialize from here. Until
we get a couple of breadth indications or handfuls of valid breakouts of
four-plus-week consolidations of up-fuel stocks daily, the benefit of doubt
belongs to being cautious. Let’s be
patient and watch what happens with the recession and new War on Terrorism,
while paying super-close attention to clear market reactions to events and to
internal market dynamics.