Watch For One More Distribution Day To Confirm Retest Within Trading Range
We’ve
now had three distribution days since the Sept. 21 lows — two of
which were relatively convincing. A move
now by the S&P 500 below 1050 on strong volume along with another CONVINCING
distribution day (meaning a down day on volume above the prior day with declines
outpacing advances and down-volume outpacing up-volume) will set up a retest of
the Sept. 21 lows. In the absence of
stronger breadth to the downside and more Bottom RS/EPS New Low breakdowns, we
suspect that any retest is part of an ongoing trading range that may develop
into an “a-b-c” type of multi-week bear market rally.Â
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.
Investors
should also note that I continue to believe that the one thing more important
than breadth indications is leadership. UNTIL
we start getting lots 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. Similarly, only when we get a lot
more downside breaks of four-plus-week consolidations (flags or cup-and-handles)
of down-fuel stocks and/or close-calls that are making our Bottom RS/EPS New
Lows list in lagging groups, THEN AND ONLY THEN
will we begin steadily increasing our allocation to the short side.
So
far, we have neither the breadth indications nor leadership indications that a
sustained uptrend is in the making, or that a new downwave is in progress.
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 14/8, 20/3, 13/6, 5/17 and 9/9.
Breadth is 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 3/0, 6/0, 0/3, 0/4 and 3/2. No
close calls on either side, meaning nothing close to a low-risk, high-reward
opportunity developing this week. Breakout
numbers are not even close to what we would expect on a daily basis on the
upside if this rally is to develop the leadership typical of a sustainable up-move.
Similarly, breakdowns are not numbering anything close to what we would
expect on a new down leg. Remember that
as the last down leg began off of the July highs, we started getting at least a
few short-selling opportunities. So far,
none are developing in this decline. Â
Economically
sensitive commodities remain clearly and universally bearish.
Cotton and copper made new lows this week, while lumber is a hair away
from new lows and bonds are making new highs. Commodities
are thus still clearly discounting recession with no recovery yet in sight.
We suspect 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 breakdown. Â
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 year 2001, we are now up
about 12.67%, with a heavy cash position.Â
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
new 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.
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 NH’s 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.
We
still suspect an eventual retest to develop sometime in the next 20 weeks until
solid evidence of recovery begins to emerge. 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 breadth indications or handfuls of valid breakouts
of four-plus-week consolidations of up-fuel stocks daily, the benefit of doubt
belongs to the bears and 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.
       Â