What Traders Need To Focus On In The Coming Days

Chinese Revaluation and More Bombs Aimed At the West

What a news-filled week!  First another stab at bombing London’s rail system was attempted.  9 million people a day use this rail system and particularly for those living outside of London but working there, the attack on this critical infrastructure is an attack on their freedom, productivity, and mobility.  London’s AIM had more IPO’s in number and dollar volume than the Nasdaq over the last twelve months with companies listing from all over the world, so don’t underestimate the importance of this global financial center.  This is an attack on global capitalism, pure and simple.  The Brits have a better spirit to endure this kind of thing than any people on earth.  They have not caved-in to appeasement like the Spanish did.  And yet, one cannot help but note that an attack on the British rail system is brilliant in sick sort of way – it is an Achille’s heel of English transport.  And with multiple attacks coming from men who were actually born in Britain, we fear the repercussions of this attack on civil rights and freedom of movement globally as governments respond to the increased awareness of threats.

Additionally in the latest week, the Chinese revalued.  Investors should understand that a 2% revaluation is a cosmetic step that will likely have few far-reaching implications, despite some short-term reactions in Asian currencies and equities.  Moreover, the fact that it was so clearly politically motivated, rather than economically, should not be lost.  Hu is coming to DC in the week’s ahead and this move was clearly designed to take some of the wind out of the sails of US protectionists (such as Schumer and Graham) whose yells have been growing troublingly louder.

Chinese revaluation ultimately will occur again, and one must remember that China is indeed committed to eventually freely floating the currency, although we believe such a shift will not be in China’s (or anyone else’s!)  interest broadly until China has done more to take care of its non-performing loans to State Enterprises and has more internal inflationary pressure.  We may now only get an extremely mild version of the eventual impact of such moves:  a lower dollar; an improving trade-balance in the US;  higher global and US bond yields;  higher gold prices;  improving US exports to China and Asia, and fewer import price declines.   These effects will come EVENTUALLY, and short-term market reaction may be similar though not long-lasting, until a more meaningful revaluation or shift to free float develops.

Yet with the present move being clearly more politically motivated than economically so, we are concerned that the protectionists in America, Schumer and Graham and Co., will take this as evidence that their pressure is working, and step up pressure on China even more. The further rising of protectionist spirits would be very sad indeed for the US and the world, and bears close watching following Hu’s visit in particular. 

Market internals are improving still and remain with a now clearly bullish bias.  Our best guess is that this is a retest rally that will either test or just slightly exceed the highs of earlier this year before petering out.  Short-term oriented higher risk traders may find some tradeable action here, but we still advice a higher than normal degree of caution for longer-term investors.  Emerging markets in Latin America, Eastern Europe and Asia are leading the advance.  Oil and resources remain strong though vulnerable to a peak in oil prices.  European financials and utilities still seem to be faring well in response to lower bond yields.  Biotech seems to be a newer leader in the current rally that traders could watch, as do semiconductors.  Soft drinks and housing continue to lead on the upside.  Midcap value and small cap sectors continue to do well relative to other segments, though small caps are up against a valuation resistance level here. 

We also had more Greenspan testimony this past week.  It seems clear that the Fed remains intent on raising short-rates, while most of the rest of the world is easing, thinking of easing, or not tightening (except Canada).  This means the yield advantage wind is behind the sails of the dollar, despite its being very overbought and many currencies opposed to it hitting very significant support levels here that should hold for at least a consolidation if not contra-trend rally.

Breadth on our TopRS/EPS New highs versus new lows lists is bullishly biased with new lows and potential shorts practically non existent. 

This week in our Top RS/EPS New Highs list published on TradingMarkets.com, we had readings of 105, 152, 205, 97, and 137 with 67 breakouts of 4+ week ranges, no valid trades and one close call in MRVL.  This week, our bottom RS/EPS New Lows recorded readings of 7, 1, 0, 0, and 0 with 0 breakdowns of 4+ week ranges, no valid trades and no close calls.  One valid signal remains in place in VLO on the long side and in IDT and UIS on the short side.  We advise caution on both sides of this aisle, though some allocation to global leaders seems prudent here.

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, and did not get to a fully allocated long exposure even during the 2003 rally.

The market continues tipping its hat toward the rally continuing on an intermediate-term basis with somewhat stronger breadth.  This is a DECENT yet NOT OUTSTANDING market environment in our opinion and investors should allocate with less than full strength until a CLEARLY better environment emerges in our opinion. 

Mark Boucher