What I Suspect About This Rally

April 25, 2003
Mark Boucher

The underlying market internals
are improving, and further follow-through and breakouts by the
averages will confirm a catchable upmove of unknown duration.
We suspect that this will be a bear-market rally of stronger and longer
duration than any since the 1999-2000 peak. A
rally of up to a year erratically moving higher before stagflation hits the
market is even possible. But
regardless of unknown length, a bull move that appears catchable seems to be
under way. The first big test is how it
behaves at prior resistance. So as
the Dow, Naz, and S&P approach resistance that has held since July, look for
some consolidation at the very least. Consolidation
followed by high-volume breakouts with a strong close and continued good breadth
would likely mean a further decent move in the wings.
Are we finally getting something here?
Time and market action will tell the tale.

We suspect Iraqi-peace news may occasionally throw the
market for a loop. Investors also
need to watch the global SARS scare. SARS
is already hitting Chinese markets pretty hard â€” and these were some of the
strongest markets in the world during the latest global slowdown.
Wild cards are still out there, and a bit more caution than normal is
still warranted.

We therefore continue to suggest that investors cautiously
add exposure as trade signals are generated, although a good volume strong break
above the resistance levels could turn us more aggressively bullish.
Wait for more confirmation.

Since
March 2000 the world index is down over 45%, the S&P over 48%, the IBD
mutual fund index is down over 62%, and the Nasdaq has crashed over 76%.
Meanwhile since March 2000 the long/short strategy we summarize and
follow-up each week in this column has made more than 39% on a worst drawdown of
under 6%. While this
performance is certainly underperforming our long-term growth rate, and it is
hardly thrilling to have been so heavily in cash since March of 2000, we have
managed to eke out gains with very low risk in a very dangerous market
environment where 9 out of 10 traders have been big losers.

Our official model portfolio overall allocation remains
SOMEWHAT DEFENSIVE. Weâ€™re
now 32% long and 8% short, with 76% cash in T-bills (short-sale cash included,
four longs and one short at 8% each) awaiting new opportunities.
Our model portfolio followed up weekly in this column was up 41% in
1999, up 82% in 2000, up 16.5% in 2001, and up 7.58% in 2002, an average annual
gain of over 36% â€” all on a worst drawdown of around 12%. Weâ€™re now
up 2.55% for the year 2003.

To our daily Top
RS/EPS New Highs list the entire rally from the 7/24 and then October lows
never even registered on the radar screen having mustered up just ONE solid week
of consistent +20 or higher readings since 7/24, which is incredible.
Weâ€™re now VERY close, with last week being close enough to a +20 every
day and new highs on our lists expanding rapidly enough that the environment is
now clearly turning better from a long-side perspective.
Bottom RS/EPS New Lows are nearly non-existent.Â

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, and 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.Â

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 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.

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 Brooks
Automation
(
BRKS |
Quote |
Chart |
News |
PowerRating)Â @8.46 (9) w/ 10.6
ops. Continue to watch our NL list
daily and to short any stock meeting our down-fuel criteria (see interactive
training module) breaking down out of a downward flag or down
cup-and-handle that is in a leading group to the downside but only add up to two
in any week (and only in the weakest groups) until we get better breadth numbers
on the downside and better leadership.

Investors and traders should be getting more excited about
the environment on the long-side. However
be patient and be sure to only buy strong breakouts that meet all of our
criteria. If indeed a multi-month
bull move is in the making, the best trades are yet to come, and waiting for
valid breakouts will allow you to substantially beat the moves of the averages
even though most trades come after the move is well on its way.
Continue to watch for confirmation that the war has ended soon enough to
prevent a global recession. Letâ€™s
hope better times are just starting to materialize here.

Mark Boucher

What I Suspect About This Rally

BUY THE FEAR, SELL THE GREED

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