What This Market Needs
The main averages had two good-volume rally days and a
decent follow-through day since last week. However, even on the biggest rally days, the breadth was nothing
spectacular. Two to 1 up to down
stocks on the Naz and 4 to 1 on the NYSE is not the kind of plurality of upside
one would usually expect to launch a new bull move. We will need more good
breadth and more Top RS/EPS New Highs
with some solid breakouts in stocks that
meet our criteria in top groups to exploit this potential move.
Watch and wait, and see if the market can deliver us some trades. We had some nice moves in
America’s Car-mart
(
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PowerRating) and Garan
(
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PowerRating) since the September low. If we can get a few trades like this in any upcoming market rallies, it
will be worth playing. We’ll just
have to see, though, whether this current rally can materialize into anything
worth investing in. We doubt it
will be a barn-burner for the averages.
The EMs appear to be in a rotational correction here. Eastern Europe, China, and parts of East Asia are making new highs while
the bulk of EMs correct. Eastern
Europe is getting overdone and is nearing the phase where monetary tightening
will have to develop, so tighten stops on these areas. China appears the best play for now, particularly red chips.
Investors in EMs need to be a bit more cautious now, with the developed
markets correcting. More
follow-through upside in the developed markets will help end the EM correction
as well.
This market continues to look like the mirror opposite of
the 1998-early 2000 market. In that
market the A/D declined and the broad market peaked and fell consistently. But
the techs continued rallying into March 2000, when they too finally fell and
played catchup in the bear move. Now
we have the A/D advancing, the broad market rallying, some thin leadership doing
quite well, while the techs continue to decline.
Could the techs spend another one to two years groping for a bottom while the
small-cap value and thin leadership sectors rally?
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Investors should watch for more indications that this rally
has teeth, while keeping one eye on the ominous potential picture we talked
about last week, should the broad market break below the September lows, with the
S&P then completing a huge MONTHLY chart Head-and-Shoulders pattern. Watch also the nearby dollar index futures for a break below the 111
level for a weekly chart double top. The
dollar bubble has mirrored the bubble in stocks — fast depreciation will spell
trouble and a potential unwinding of the dollar bull move.
This week it appears that the
Australian dollar (AUD) and New
Zealand dollar (NZD) completed major
weekly bottoming formations with valid breakouts. The
euro (EUR) would also complete a weekly bottom on a move over 94, which would likely
signal the end for the dollar. Gold
would complete a huge double bottom on the monthly chart on a solid close above
340.
All of these occurring in
close proximity, along with the above-mentioned breakdown in stocks, would be an
ominous sign that the dollar and stock bubble are deflating rapidly and we’re
headed for a more inflationary environment where assets outside of the U.S. are
the main protection of capital. We
don’t yet see signs that this dark scenario is developing in terms of market
breadth — but investors need to keep this potential scenario in the back of
their minds. Inflation would favor
hard assets, other currencies, EMs, commodities, and real estate, should this
develop. It’s not the odds
favorite right now, but don’t miss a huge sea change if this develops.
An orderly decline in the dollar will not threaten the global recovery,
whereas a sharp decline will threaten and shock it.
Our odds favorite scenario continues to be a
LONG trading
range in developed markets, similar to the environment of 1965-1982, with
intermittent mini-bull and mini-bear moves for the next 5+ years.
EMs MAY be launching a secular bull market that would be much more
profitable and playable.What the US market needs is more
Ciscos — more
earnings gains evidence so that earnings gains begin to take over from monetary
stimulus as the fuel behind stock price gains. But so far it has been relatively
profitless for U.S. companies. Is the Cisco/GE improved outlook the beginning of the earnings phase of
the recovery? Watch
for breadth and leadership before anticipating any kind of real rally developing
— and then only expect a potential MINI bull move
In the meantime, our US long/short strategy continues to
show reasonable gains with very low risk this year.
We’re making money at a 20%+ rate so far this year. OK, but not exactly
wonderful. Investors may have to
adjust to a lengthy period of global multiple convergence, where overvalued U.S.
stocks have trouble rallying en masse
for many years, while certain sectors present limited but good opportunities
such as we’ve seen in the homebuilding industry this year. And while our strategy profit is decent, it isn’t as large as those
investors who have taken our suggestion and ventured into the Emerging Markets
— where we suspect most of this year’s gains will be made.
Continue to monitor the commodity markets. Some commodity indexes touched old highs this week in response to
temporarily higher oil prices, but the majority of commodity prices are still
consolidating. Breakouts in less
economically sensitive commodities, like sugar this week, may help build broader
index support for a commodity rally ahead. Economically sensitive commodity indexes and markets are on the whole
still positive the recovery scenario. Weakness
now in copper, cotton, Lumber, and commodity currencies, accompanied by further
strength in global bonds, would signal a softening in growth and a change in
scenario. With breakouts this week
in the NZD and AUD, this becomes less likely.
Now watch for renewed new highs in Cotton, Copper and Lumber which would
signal a reacceleration of the global recovery. Remember to let the plurality of markets be your guide.
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Top
RS/EPS New Highs this past week were 23, 11, 8, 31, and 36 — not yet above
20 each day but improving toward the end of the week.
We need more quality leadership for this rally to take hold.
Bottom
RS/EPS New Lows collapsed this week with 8, 24, 13, 3, and 5 readings and
only 7 breakdowns with no real close calls.
Further declines in new lows at the expense of new highs next week will
give credence to this rally. Right
now, opportunities on both the long and short sides are scarce.
Our overall allocation remains
DEFENSIVE.
We’re now around 9% long and 7% short, with about 98% in T-bills
(including short sale proceeds) 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 up over 9.55% for the year 2002, mainly driven by a select couple of names,
which is often the case in a market that is searching for leadership. Due to
the volatile nature of the U.S. market, we will probably see more frequent and
larger drawdowns than we’ve had so far, if we can ever get to the point of
more aggressive allocation that is.
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, the course “The Science of Trading,” and the 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 the US 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.
Upside breakouts meeting up-fuel criteria (and still open
positions) so far this year are: Garan
(
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PowerRating) @45.60 —out this week on 62 ops; Land’s End
(
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PowerRating) @52 (61.78) — now take
profits on takeover; and Group
1 Automotive
(
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PowerRating) @44.84
(49.71) w/ a 45 ops. Continue to watch our NH list and buy flags or
cup-and-handle breakouts in NH’s meeting our up-fuel criteria — but be sure to
only add names that are in leading groups, and now only add two trades per week
once again until the market environment improves.
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: Mediacom
Communication
(
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PowerRating) @10.54 (11.82) w/ 12 ops.
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 to the downside but only add up to two
in any week until market weakness is more pronounced.
Traders and investors now need to stay lean, mean, and
watch the broad markets like a hawk. Watch
the plurality of the markets in general for clues on how to move next. Further indication of recovery will show up in commodity prices and
further rallies in developed markets, giving EMs a further push. Deflationary and inflationary scenarios also need to be monitored.