Watch These Potential Party-Killers

August 22, 2003
Mark Boucher

In the past week, a large number of sectors and countries have broken out of their trading ranges of June-August, so that a plurality of international
markets are beginning to point to the trading range on the US major averages
being resolved to the upside without a more common 1/3-2/3 correction.Â New highs
and/or breakouts occurred in US dollar terms in Thailand, China, India, Poland,
South Africa, gold stocks, and small-cap emerging markets Â (our seven favorite
countries and categories), Taiwan, Japan, Â Belgium, Hong Kong, Malaysia,
Singapore, Korea, Sweden, Norway, Greece, Russia, Brazil, Chile, Peru, as well
as on cyclical indexes, small cap value and resources (favorite two US segments
now, in accelerating growth and rising inflation environment), and the
Dow.Â Thatâ€™s a decent plurality beginning to build that we suspect will be
followed by the US market eventually.

Our base scenario continues to be that
a broad global economic recovery is likely to lead all global stock markets
higher over the intermediate term.Â Leading economic indicators and the ratio of
coincident to lagging indicators in over 30 different countries have turned up
over the last few months.Â Global stock markets have put in their best Â and
most concerted rallies since 2000. Base metal prices are breaking out of bases
(tin and nickel this past week, base metal stocks like Inco and Phelps Dodge
are breaking out and leading the stock rally, economically sensitive industrial
commodity prices are breaking out to their highest levels in years, and resource
funds like PSPFX, RSNRX, QRAAX, and PCRIX lead the rally.Â Our favorite
country regions are all at new highs this past week, including a breakout by
Thailand (and Taiwan), and new highs in China, India, much of Asia, and Eastern
Europe, and South Africa. Gold and silver stocks are breaking out and moving to
new highs.

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As we mentioned last week, there are still potential party killers investors
need to watch.Â Note that bonds stopped right at the long-term trend channel
support level (resistance level on the chart of yields) that we published last
month, which is just what needed to happen for this rally to continue.Â Over
4.75% on the 10-year government bond will begin to hit ALL global equities and
kill this mini-bull market.Â Oil is rallying but still below the critical
$38-$40 range that will also act as a recovery killer.Â Right now, the dollar is
rallying as global investors come to the realization that growth in the US will
surprise on the upside, while growth in Euroland will surprise on the downside in
the quarter ahead.Â As long as the dollar is not cascading lower, growing Middle
East control of the global current account surplus the US needs to fund its
debts will not be a threat to the recovery either.Â The wild card of another
major terrorist incident still hangs large and represents a major risk to
investors, especially with the doomed-from-the-outset Israeli peace deal falling
apart rapidly. It appears likely that in September the Bush team will actually
announce strong evidence of WMD projects they found as well as determine new
policy toward the guerilla war.

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The situation thus remains that a growing plurality of variables lead us to expect that the global recovery is
on track and is developing as anticipated, investors need to understand that
there are threats to this scenario and they should watch them closely. The euro has fallen below the
1.10 support level and should now test the 1.02 level, which may later this year
prove a very good support level to buy.Â The AUD and CD look ready to fall lower
now as well.Â The yen is holding up well, as it usually outperforms during
global economic acceleration.Â Japan, particularly small cap, is our favorite
major developed market during this leg up.Â Gold and silver stocks creep ever
higher while the metals display surprising strength to hold up while the
currencies are getting pummeled.Â Are global investors beginning to catch on
that gold itself is the only refuge to competitive devaluations?

Our internal breadth tools are
improving in the US market as well.Â Last week was the first one in months in
which our Top RS/EPS New Highs list stayed above 20 each day.Â Breakouts
expanded to 33 and quality has begun to improve.Â Note that the Naz and Dow
have broken above our critical breakout levels and only the S&P is lagging and
needs to confirm a new leg up with a breakout above 1025.

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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.Â 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 methodologies should have
portfolios up over 10.8% ytd by our calculations) â€” all on worst drawdown of
under 7%.

Last week in our Top RS/EPS New Highs list published on TradingMarkets.com, we
had readings of 54, 30, 77, 108, and 75, accompanied by 33 breakouts of 4+ week
ranges, no valid trades and two close calls in
(
DGIN |
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Chart |
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PowerRating),
(
FDRY |
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PowerRating), and
(
SE |
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PowerRating).Â With New Highs above 20 consistently the assault on a valid breakout of this
trading range is gaining credibility.Â 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.Â Bottom RS/EPS New Lows are still
quite weak (through improving now) with readings of 6, 2, 4, 3, and 0, with 1
breakdown of a 4+ week pattern, no valid trades, and no close calls.Â The
short-side remains pretty bleak, though health care indexes are clearly underperforming and should make up a sizeable percentage of short exposure for
those desiring some.

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.

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The stalemate is starting to give way to a new leg higher.Â Foreign markets are
leading and will continue to outperform.Â Gold, resources, and our close calls
should give investors all the selections they need to participate with caution
in this next leg up.

Mark Boucher

Watch These Potential Party-Killers

BUY THE FEAR, SELL THE GREED

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