Why You Should Watch Global Equity Leadership Now
This
week, the market reacted off of Fibonacci resistance on Fibonacci
time zones — something that often occurs before a more meaningful correction or
prolonged consolidation. But the evidence is still not conclusive whether this
market can just consolidate for a while before pushing higher, or a meaningful
correction within the context of the mini-bull market will develop before the
economy gains enough steam to push expectations higher. Of course a shock or
severe policy error could still force us into new lows, but this remains a lower
odds alternative as long as such strong and concerted central bank intervention
and fiscal stimulus are in the works.
As we’ve been discussing over
the past few weeks, sentiment and insider buy/sell ratio data point to a likely
correction of the run-up since March. Bonds have peaked, possibly on a secular
basis, from bubble prices, globally. The normal pattern for stocks is that they
correct during the initial run-up of rates in a recovery, but that once economic
growth acceleration becomes clear, stocks move up in another leg to new highs,
while bond prices retreat further and languish. We need MORE evidence of
earnings growth and economic growth to develop before this market can move
higher. Whether that happens before a correction or not is the main question
we’re monitoring. Thursday was another
distribution day — not a good sign. Watch the uptrend lines and the
intermediate support zones we’ve been publishing for weeks for indications of
whether this correction will retrace 50%-67% of the move since March before
gaining new legs: S&P below 960, Dow below 8940, AND Naz below 1590.
Conversely, watch for accumulation days and new highs on strong volume in all
the major indexes above 1025, 9375, and 1700 respectively to confirm a new leg
up, although we would expect the period of consolidation or correction to last
many more weeks here.
Investors should note that the
bond route has been global — with Japan having been hit the hardest — as
reflationary policy there is an abrupt turnaround. We expect Japanese rates to
climb above 2% in the next year as long as reflationary policy continues, which
is likely. We expect US bond rates to climb over 5%. Euro bond rate rises
should develop but lag. We suspect that these run-ups in rates WON’T yet be
enough to strangle economic recovery, market recovery, or real estate prices.
But once inflationary pressures really build, that story will change. We don’t
know when inflationary pressures will grow enough to force interest rates high
enough to hit the markets — it could be late next year or in two or even three
years. But when it happens the markets will likely roll over and make new
eventual lows or a strong retest. So the clock is ticking on this recovery and
on this market move up.
Watch the global equity
leadership for clues as to whether the current consolidation will get nastier.
Leadership for this move has been in China (still close to new highs but getting
overdone), Thailand (still close to new highs though getting overdone), India
(still close to new highs but also getting overdone), Russia (now starting to
correct), Latin America (also starting to give hints of correcting), US small
cap value (starting to correct) and small cap value in Emerging Markets (still
close to new highs). If indeed the US market only undergoes a consolidation
these global leaders will not likely do much more than consolidate at a very
high level and some may continue to march to new highs. On the other hand, if
all these leaders start to decline in sympathy with the US market decline, a
correction of more size will become much more likely.
The same is true for the
internal US market leading groups. The leading sectors of the US rally have
been biotech and medical related (starting to correct?), telecom (already
leading correction), Internet related (already correcting), Home
Building/RE/Mortgage (still strong but beginning to correct), Natural Gas
(already in correction), and software (correction started). Small-cap value is
the leading segment of the market, which is consistent with the pre to beginning
inflation part of the cycle (late cycle). Downside leadership for shorts is
barely existent, but as you can see, the leadership on the long side of the
domestic market is starting to breakdown a bit.
We still believe that
aggressive central bank and fiscal action that will lead to a new leg up after
the current correction/consolidation, but that investors will have to be
extremely flexible and very nimble to do well in this environment. As always,
watch for confirmation by breadth and internals before moving into any asset
class aggressively — and be ready to pull the plug on nearly any stock
investment at a moments notice if breadth and technicals align in a negative
fashion.
Yesterday the head of armed
forces in Iraq admitted that a significant guerrilla war is underway in Iraq.
Investors should anticipate a shock to the markets if and when a re-expansion of
the on-going war is announced officially.
Investors should continue to cautiously add stock exposure as
trade signals are generated that meet our strict criteria. 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 — 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 32, 38, 89, 50, and 29, accompanied by 6
breakouts of 4+ week ranges, and one valid trade in CCRT and a close call in DRL.
With new daily highs again above 20 consistently the market has a shot at
continuing the rally as long as these hold up. The action continues to rate as
cautiously bullish biased, but nothing like that of the great bull markets of
the 1980’s or 1990’s. On a major secular bull move we would see 100’s of
breakouts in close calls or stocks meeting our criteria, not just 6. Remember
to try and 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 last week, as
they have been since mid-April, showing low readings of 0, 1, 2, 1, and 0, with
0 breakdowns of 4+ week patterns, no valid trades, and no close calls, so the
short-side remains muted.
Continue to watch our NH
list and buy flags or cup-and-handle breakouts in NH’s meeting our up-fuel
criteria that are in leading groups, but add no more than two positions a week.
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.
On the long side, we like
(
CCRT |
Quote |
Chart |
News |
PowerRating),
(
SFNT |
Quote |
Chart |
News |
PowerRating),
(
AVID |
Quote |
Chart |
News |
PowerRating) and
(
UNTD |
Quote |
Chart |
News |
PowerRating) still and the
close call this week,
(
DRL |
Quote |
Chart |
News |
PowerRating). No short-side opportunities have developed via our
strategy for some time. We also like conservative gold stocks, like FCX pfd A
and
(
NEM |
Quote |
Chart |
News |
PowerRating), some broad EM exposure like DEMSX, Eastern Europe, China, and Thailand,
in particular — though here investors may want to tread cautiously until it is
clear that the correction/consolidation is ending.
Technicals and breadth have yet to confirm whether the massive
liquidity infusion is going to have traction quickly, or whether a more
meaningful correction is upon us, though the correction camp gained ground this
past week. Hold only your strongest positions now and wait to rotate into new
breakouts once this consolidation/correction is over. Continue to watch for
clear leadership in leading new industries and plurality of breakouts in those
industries, for follow-through by close call and criteria stocks, for breakouts
by the averages that will confirm if this bear-market rally has legs, and for
further breadth thrusts, to tell us that a better bullish cycle is developing
here.
Mark Boucher