Window Of Opportunity For Longs?
I’m writing this a day earlier than normal
but it appears that we’ll have our first week with new highs on our Top RS/EPS
new highs list consistently above 20 for the first time since 2001! Leadership
and breadth are STARTING to appear more decent. We
have a window of opportunity going into year end where the market usually
rallies, and the war will probably be delayed until February, so it won’t
dominate the news.
Earnings are increasing, though mostly from cost-cutting. It appears to me that
this rally is likely to continue through January and has the possibility to be
the best rally we’ve seen so far in this bear market. Leadership, breadth, and
follow-through remain the keys. These are all OK but not good or great. But
we’ll take what we can get in this bear market rally that
COULD last through much of 2003 given the right war outcome and economic
recovery. The Q’s and Naz DID breakout as we
suggested
last week, adding more credibility and odds that this rally will continue.
The ECB will loosen
on Dec. 5 — either 25 or quite possibly even 50 bp’s. Concerted central bank
intervention toward stimulus is developing clearly and this
SHOULD give the market a push. Take very limited
and targeted shots but keep ammo for better breadth and follow-through,
hopefully soon. Let’s see if this “B†rally we’ve been anticipating for months
can really begin to materialize.
Economically
sensitive commodities show an upward bias, confirming the rally. Cotton and
copper are strong and on the verge of breaking out to confirm upmoves in the
making. Bonds are range trading. Lumber had a false breakout down and is now
back in its base. Real clarity would come if cotton and copper followed through
with good volume on the upside, Lumber took out last month’s highs, and bonds
took out last month’s lows.
Junk bond yields
ARE declining, and the pace is improving,
confirming that a better economic environment is being discounted in this
critical market. Commodity currencies remain positive — though it would be
helpful if they were able to breakout to new highs. The dollar looked like it
was on the ropes, but traders re-evaluated the fact that lower rates in the US
meant that the US economy would be stronger than in Europe. Japanese policy is
too volatile to trade the yen. The dollar appears in a broad and long trading
range, which is neutral the market environment.
Thus the broad array
of markets we look at in different asset classes are mildly confirming that the
market can continue higher.
The breadth and
leadership of the rally since the 10/10 lows is improving, though not clearly
strong. We have had two follow-through days, and one breadth thrust during this
rally. It would be very helpful to have more breadth thrusts like another
follow-through day up, a 9/1 up/down volume day, 5-day moving average of
advancing volume to be 77% or more of total volume, an 11-day A/D ratio of 1.9
or more, or a 10-day A/D ratio of 2 or more.
True, since June we’ve had both a 9/1 volume day and an 11 day ma of a/d over
1.9, which is the best showing via volume thrusts the market has displayed since
the October 1998 lows. So far the rally has been mainly concentrated in the
weakest stocks of the prior bear move, and leadership is just now beginning to
show signs of life. The stocks that have broken out have not had solid
continuation, though there are signs this is beginning to improve. If volume,
breadth, and leadership can emerge, we suspect this rally could develop into the
strongest and longest bear-market rally we’ve seen since the March 2000
peak. Let’s tip-toe into the long side here while continuing to wait with
substantial allocation for stronger evidence of leadership and follow-through.
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 38% 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 VERY DEFENSIVE.
We’re now 92% in T-bills awaiting new opportunities, with one sole long
position. 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
around 6.88% for the year 2002.
Top RS/EPS New Highs have just mustered
up their first single solid week of consistent +20 or higher readings since the
7/24 lows. Readings this week were 49, 31, 35, and 21, and it looks another 20+
day is developing on Wednesday (written this morning), accompanied by 17
breakouts of 4+ week consolidations within these new highs, with some close
calls and one valid trade in
(
PORT |
Quote |
Chart |
News |
PowerRating). Let’s see if we can get 20+ breakouts
consistently, some follow-through on close-call breakouts, and some consistent
group leadership. Bottom
RS/EPS New Lows continue to deteriorate with readings of 1, 3, 3, and 4,
accompanied by just 2 breakdowns of a 4+ week consolidation, with no close
calls. Notice that our analysis of new low breakout quality helped keep us from
getting trapped on the overly bearish side of the market in the decline from
late August.
For those not familiar with our long/short strategies, we suggest you review my
book,
The Hedge Fund Edge, course “The Science of Trading,” and
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 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:
Port Financial
(
PORT |
Quote |
Chart |
News |
PowerRating)
@40.99 (42.85) w/ 37.2 ops. PORT broke out on a solid trust day of a range its
been trading in since August and then followed through with a nice outside day
up thrust on high volume a few days later. It is in the leading banking sector
that is benefiting from lower rates. Last two quarters showed +75% and +65%
earnings growth with a PE of 18 giving it a substantial discount to its
long-term growth rate of 35%. EPS was 99 and RS 90. Debt is 0% and funds and
banks are 27% and showing a trend of increasing, meaning institutions are
accumulating this undervalued growth play. 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 leadership and follow-through improve (soon?).
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: NONE. Continue to watch our NL list
daily and to short any stock meeting our down-fuel criteria 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.
The markets continue
to inch toward giving us more confirmation of the “B†wave up we’ve been
talking about since the summer. There is probably a window of opportunity into
late January for this rally to continue and to give us some long-side
opportunities that we expect PORT is just the first of. There is even the
possibility that with some good war news and better recovery data, this rally
could last WELL into 2003 and possibly longer,
though it would only be a cyclical rally within an on-going secular bear
market. But we’ll have to keep our finger on its pulse the whole time and
re-evaluate constantly breadth and leadership. Let’s hope that follow-through
develops more clearly along with better leadership to give us some real
opportunities we can sink our teeth into, at least for trades, if not for
positions.
Until next week,
Mark