Why Next Week Is Important For The S&P
We are still looking for further
follow-through up days and breakouts by the averages that will
confirm a catchable up move of unknown duration. The major averages have clearly
broken through the March-April resistance levels of 910 in the S&P and 1450 in
the Naz. Now the S&P is approaching its October-January resistance level of 955
and technicals and fundamentals are indicating that this level will be
broken. Last week the Naz broke through its October-January resistance level of
1520. The Dow still is currently flirting with its March-April resistance of
8850. The positive news continues to be that up days have coincided with higher
volume and down days have coincided with lower volume, just what we are looking
for during a consolidation and subsequent breakout phase of a bear market rally.
We continue to suspect that this bear market rally will be
of stronger and longer duration than any since the ’99-2000 peak. The current
rally is equal to the strength and duration of the rally from October-December
2002. Watch closely during the next week to see how the S&P performs around this
essential resistance level. A rally of up to a year erratically moving higher
before stag-flation hits the market is possible. To continue this bear market
rally, we will need to see more high-volume breakouts from leading groups. Watch
market action, as well as our Top RS and EPS list for weeks with more than 20
breakouts of four-plus-week consolidations for confirmation of a market
breakout.
The equity indices of most of the largest developed markets
have broken above their 200-day moving averages and continue to perform
well. Even the indices of the Asian nations affected by the SARS virus have
jumped up from their lows. Most notably, China’s index has broken above its
200-day moving average despite the newfound threat of inflation. SARS continues
to be more deadly than previously thought, but China’s economy has shown its
resilience by growing 8.9% in April. Treasuries and T-Bills continue to rally to
new highs despite the strength of the stock market. This market action signals
that mortgage refinancing will continue, a big positive for household balance
sheets and spending power. In fact, housing demand remains firm and inventories
of new homes remains near record lows.
Continue to watch for signs of an increase in capital
equipment spending as the ultimate signal that the economy has not only bottomed
but has also begun to grow healthily again. Watch to see if the Fed’s prediction
at the March 18 FOMC meeting comes true, “A positive outcome of the war in Iraq
should have a favorable impact on capital spending, especially if accompanied by
a rally in the stock market.†If not, we may see another monetary loosening at
this summer’s next Fed meeting. With the fixed income and equity markets
diverging in opposite directions, the question remains, “Which market is
right?†With the 10-year treasury yielding a very low 3.5%, yields have little
downside, although they may remain at this level for a while until there are
definite signs of economic improvement and the Fed is forced to tighten monetary
policy to ward off inflation. In this environment, we look to weigh more
heavily to equities as opportunities become available.
The conditions are in place for an expanding economy with
the end of the war — the lowest interest rates in 40 years and continued
consumer buying power. First quarter earnings announcements finished positively
above estimates and companies have issued positive guidance going forward.
Consumer confidence is rising and employment data is not as bad as it may
seem. Although first-time jobless claims continue to come in above 400,000, the
bulk of layoff announcements have come from state and local governments trying
to balance their budgets. The only region of the US that is suffering from
employment contraction is the manufacturing intensive Midwest which accounts for
23% of the employed in the US. Since the Chinese yuan is pegged to the dollar,
the weakening dollar will not help very much in the Midwest’s battle with China
for manufacturing contracts. The dollar is hitting four-year lows against the
euro which will stimulate US exports until the Euro Zone cuts rates in June.
Still, with a 50 bp rate cut in June, the Euro Zone will be
behind the curve in fighting economic weakness. The stringent standards of the
Euro Zone are proving to be self destructive in economically weak times when
deficit spending needs to increase along with other forms of economic stimulus
in order to get the Euro Zone economy growing again. Investors have fully
factored in the positive news from the War on Terrorism, and any major shock
could throw the market for a loop. The biggest terror attack on US citizens
since Sept. 11 this week in Saudi Arabia, although relatively minor, had little
market consequence.
Investors should continue to add exposure as trade signals
are generated. A good volume, strong breakout above the resistance levels will
turn us more aggressively bullish. All of the conditions are in place for a
stock market rally, now we await market follow through.
Since
March 2000, the world index is down over 41%, the S&P over 40%, the IBD mutual
fund index is down over 60%, and the Nasdaq has crashed over 70%. Meanwhile
since March 2000, the long/short strategy we summarize and follow-up each week
in this column has made more than 44% 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. We’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% — all on a worst drawdown of
around 12%. We’re now up 3.95% for the year 2003.
This past week our daily
Top RS/EPS New Highs registered seven breakouts of four-plus-week
ranges. Look for positive market breadth indicators in the near-term and
hopefully more weeks with 20 or greater new 52-week highs while the market
churns. Bottom RS/EPS New Lows continue to be non-existent as they have been
since mid-April. We had readings of 24, 28, 66, 63 and 54 in our Top RS/EPS New
Highs list, accompanied by seven breakouts of a four-plus-week range, no valid
trades and close calls in
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PowerRating),
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PowerRating),
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PowerRating) and
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PowerRating). We
have been lucky enough to take advantage of strong breakout opportunities that
have presented themselves in the past month and await further opportunities if
the market can remain strong. Bottom RS/EPS New Lows were almost non-existent
last week showing low readings of 1, 0, 1, 1 and 0, no breakdowns of a
four-plus-week pattern and no close calls. The high ratio of new highs to new
lows should continue as we wade through this key market resistance level.
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. 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.
Upside breakouts meeting up-fuel criteria (and still open
positions) so far this year are: Garmin
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PowerRating) @34.79 (47.78) w/41 ops; STET Hellas
Telecommunications
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PowerRating) @8.64 (9.14) w/8.2 ops (ignore the
bad low tick on 5/15); Avid Technology
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PowerRating) @25.1 (27.62) w/26.0 ops; and Cyberonics
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PowerRating) @22.46 (21.52) w/ 20.5 ops. Continue to watch our NH list and
buy flags or cup-and-handle breakouts in NH’s meeting our up-fuel criteria —
we’ll continue to advise adding only two stocks per week that are in clearly
leading groups until we get clear breakouts in all the averages.
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) NONE. This week we were stopped
out of Brooks Automation
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PowerRating) (in
@8.46) at our 9.8 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. Better times seem to be materializing here.