Why You Should Watch Global Bonds Closely

November 7, 2003
Mark Boucher

Weâ€™ve
done a good job of highlighting the primary
sectors benefiting
most from the global liquidity cycle this year. Asia, mining, base metals, Eastern
Europe, and Emerging Markets have had an incredible run, all up over 40% since
March.

However, investors should
realize that the majority of the liquidity-induced rally is over. What this
market needs to do here as the US and global economies begin to show more evidence
of the stronger-than-expected recovery weâ€™ve been anticipating, is transition
from a liquidity- and deficit-induced move to a profit-driven upmove. This is
essentially a transition from phase one to phase two of a normal three phase
cyclical bull market â€” though the present environment is a mini-version
of a normal cyclical upmove.

Normally, the market experiences
a decent correction of 10%+ during such a transition. Whether this will occur
fairly soon or following one more leg up, we have yet to see â€” but keep
in mind that such a correction is becoming more likely than at any time since
the March rally started in the next quarter or two.

While the soaring GDP growth
rates and improving employment picture are coming more clearly into focus for
investors with the slew of stronger US and global economic reports coming out,
the downside is that stronger economic evidence is leading to higher global
interest rates. This past week, Australia and Great Britain were the first developed
markets to actually raise interest rates. We expect more rate hikes by both,
particularly Australia, in the period ahead as a global synchronized recovery
materializes.

Many economists are theorizing
that the burst of growth in the US wonâ€™t last, but it appears that growth
in employment by small businesses and stronger capital spending will make this
recovery self-sustaining, albeit at a more subdued pace than the torrid growth
of the last quarter. In addition, the global nature of the recovery will help
keep the US on track.

Thus it becomes critical
for investors to watch global bonds closely from here on out. If global bond
prices can stay in a range while the recovery develops, then the recovery can
continue for many quarters. If however, global bond prices begin dropping to
new lows with swift drops in unison on further news of the global economic recovery,
then rates could cut this recovery short before the end of next year.

Unlike other recoveries,
in this one we suggest investors get less bullish as the markets move
higher, not more bullish.

Asia and broad EMs have
continued to move higher here. Eastern Europe is recovering from Russiaâ€™s
Yukos fears. Latin America is holding up, though leading Chile is finally correcting
after being a leader in the region all this year. Resources and junior mining
continues on an absolute tear that will likely accelerate once developed markets
join Asia in strong recoveries.

As we warned last
week, the euro did indeed move below 1.15 in response to reports of stronger
economic growth, which may usher in a period of dollar strength/trading range
for the next many weeks or months. Investors were advised to take profits on
commodity currencies on the euro decline. Gold
is also in a critical consolidation. If gold falls below 370, it will experience
a real correction that will likely impact mining stocks heavily. If it can stay
above 370 while the dollar rallies
and then lead the currencies up after this period of dollar strength, it may
be able to take over global currency leadership and begin moving up vs. almost
all global currencies. This would be very bullish. Nonetheless junior mining
stocks are soaring and investors need to become much more cautious if gold breaks
down.

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The main trend continues
to be up for both US and global equities, but things are overdone in most markets
and they are therefore vulnerable to setbacks at any time. Massive fiscal and
monetary stimulus has worked its magic in terms of starting the fire of recovery
â€” now lets see how that fire catches in terms of profit-growth.

It still appears that the
most likely dangers that could derail the recovery remain:
a
global bond rout, a dollar crash, a renewed oil crunch and price surge, or
a major terrorist action that breaks the back of consumer confidence.

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Our US long/short model
is doing reasonable well, considering the low level of allocation it has had.
We have long encouraged investors to supplement this strategy with or favorite
foreign and global asset plays. 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. 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 US only methodologies should have portfolios up over 11% ytd by our calculations)
â€” all on worst drawdown of under 7%.

Last week in our Top
RS and EPS New High List published on TradingMarkets.com, we had readings
of 98, 42, 113, 89, and 72, accompanied by 11 breakouts of 4+ week ranges, no
valid trades and no close calls. Internal strength has come back SOME, but still
remains slightly suspicious. 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. Bottom
RS/EPS New Lows remained non-existent with readings of 2, 2, 1, 5, and 1
with no breakdowns of 4+ week ranges, no valid trades and no close calls. The
short-side remains bleak.

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.

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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 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.

We also like broad metal
stocks, like FCX, small-cap Emerging Markets in
general, metals and resources, South
Africa, broad Latin America,
and broad Eastern Europe (on a
good upside reversal on high volume) and broad Asia.
But use tight stops in all of these plays as the upside party is well established
and a bit overdone.

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We still believe that weâ€™ll
have to be very nimble to profit consistently and know when to pull the plug
in this market, and when to time the hiccups. A mini-mania could develop if
global economic statistics start to change investor psychology â€” or a
shock could tank this market so quickly it would make you dizzy. Weâ€™re
probably going to experience a 10%+ correction as the market transitions from
liquidity to growth as its fuel. Thatâ€™s why we suggest using funds and
vehicles that are liquid enough to get in and out of quickly for our current
exposure to top relative strength markets. Investors are advised to remain extremely
flexible.

Mark Boucher

Why You Should Watch Global Bonds Closely

BUY THE FEAR, SELL THE GREED

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