What I Suspect About This Rally

The underlying market internals are improving, and further follow-through and breakouts by the averages will confirm a catchable upmove of unknown duration. We suspect that this will be a bear-market rally of stronger and longer duration than any since the 1999-2000 peak. A rally of up to a year erratically moving higher before stagflation hits the market is even possible. But regardless of unknown length, a bull move that appears catchable seems to be under way. The first big test is how it behaves at prior resistance. So as the Dow, Naz, and S&P approach resistance that has held since July, look for some consolidation at the very least. Consolidation followed by high-volume breakouts with a strong close and continued good breadth would likely mean a further decent move in the wings. Are we finally getting something here? Time and market action will tell the tale.

We suspect Iraqi-peace news may occasionally throw the market for a loop. Investors also need to watch the global SARS scare. SARS is already hitting Chinese markets pretty hard – and these were some of the strongest markets in the world during the latest global slowdown. Wild cards are still out there, and a bit more caution than normal is still warranted.

We therefore continue to suggest that investors cautiously add exposure as trade signals are generated, although a good volume strong break above the resistance levels could turn us more aggressively bullish. Wait for more confirmation.

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 39% 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 2.55% for the year 2003.

To our daily Top RS/EPS New Highs list the entire rally from the 7/24 and then October lows never even registered on the radar screen having mustered up just ONE solid week of consistent +20 or higher readings since 7/24, which is incredible. We’re now VERY close, with last week being close enough to a +20 every day and new highs on our lists expanding rapidly enough that the environment is now clearly turning better from a long-side perspective. Bottom RS/EPS New Lows are nearly non-existent. 

We had readings of 30, 19, 64, 73, and 93 in our Top RS/EPS New Highs list, accompanied by 14 breakouts of a 4+ week range, with one valid trade in Cyberonics (CYBX | Quote | Chart | News | PowerRating) and some close calls in Vital Images (VTAL | Quote | Chart | News | PowerRating), Rofin-sinar Technology (RSTI | Quote | Chart | News | PowerRating), Middleby Corp. (MIDD | Quote | Chart | News | PowerRating), Rollins (ROL | Quote | Chart | News | PowerRating), and Optelecom (OPTC | Quote | Chart | News | PowerRating). We’re starting to get more opportunities in more abundance. Bottom RS/EPS New Lows last week showed low readings of 1, 4, 2, 2, and 2, with only 1 breakdown of 4+ week patterns with no close calls. Right now long trades are expanding nicely while short sale trades are non-existent. Let’s see if this continues as we hit some market resistance overhead.

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: Port Financial (PORT | Quote | Chart | News | PowerRating) @40.99-took profits at 53.5; Garmin Ltd (GRMN | Quote | Chart | News | PowerRating) @34.79 (39.43) now use 35 ops; Stet Hellas Telecomm  (STHLY | Quote | Chart | News | PowerRating) @8.64 (8.8) w/ 7.8 ops; Avid Technology (AVID | Quote | Chart | News | PowerRating) @25.1 (27) w/ 23.25 ops; and new this week Cyberonics (CYBX | Quote | Chart | News | PowerRating) @22.46 (22.74) 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) in Brooks Automation (BRKS | Quote | Chart | News | PowerRating)  @8.46 (9) w/ 10.6 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. Let’s hope better times are just starting to materialize here.

Mark Boucher