I Strongly Suggest Investors Watch Bonds--Here's Why

Dollar and Fed Concerns Hit Global Equity Markets

No sooner did 2004 end than the markets have abruptly reversed course with key reversals in most global markets and swift decline to follow.  Two distribution days developed in a row, sending caution signs.  The dollar’s strength was the first surprise to the market.  We have been warning investors to pay close attention to the dollar and that it was likely to correct higher as it approached the 80 support level.  This has indeed played out so far, with the Swissy and BP already having broken down out of double tops and the Euro close to doing so and confirming on a close below 1.313.

The Fed also surprised the markets when the minutes of the last Fed meeting revealed that a number of Fed officials are substantially concerned about inflation and asset bubbles and that they view the pace of expansion as on the fast side.  The inference is that the Fed will indeed be raising rates further and perhaps more aggressively than previously assumed by the markets.  Bonds have fallen some, and 10-year nearby futures need to fall below 110 to establish a top pattern, which is not yet imminent.  Yet many interest rate sensitive sectors of the market have taken big hits and made intermediate-term highs at least, such as REITS.  As resources, materials, industrials, internets, REITS, and small caps have all been leaders of the rally since 2003, their breakdowns are troubling and indicative of leadership failure.  The same is true globally to some extent as Latin America and South Africa have turned down sharply in intermediate topping patterns as well.  We suspect a correction is upon us that will last with the dollar rally and will lead to some of the laggards such as staples, health care, Europe, and Large-caps picking up RS from here on.  Investors are encouraged to take some profits and tighten trailing stops and remain nimble in this volatile and treacherous environment.

And we continue to strongly suggest investors watch bonds very carefully from here on in.  As soon as bonds turn down significantly, the punchbowl could be removed from the party much quicker than anyone imagines.   Investors need to trade tactically and keep one finger on the trigger to exit market positions during 2005. 

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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 had portfolios up 17% for the year 2003) – all on worst drawdown of under 7%.   This did not include our foreign stock recommendations that had spectacular performance in 2003. 

This week in our Top RS/EPS New Highs list published on TradingMarkets.com, we had readings of 98, 94, 89, 24, and 13 with 13 breakouts of 4+ week ranges, no valid trades  and one close call in LSCP.  Breadth is expanding again and more close calls would be a call to add some long exposure.  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.  This week, our bottom RS/EPS New Lows recorded readings of 0, 1, 4, 3, and 3 with 3 breakdowns of a 4+ week ranges, no valid trades and no close calls.  We’re seeing a growing number of valid breakouts, though this is not a gung-ho environment.  Valid signals are in place in MLI, GBX, and BHP.  The rally is still in place but starting to thin in breadth here, so investors should remain aware of possible headwinds looming as discussed over the last few weeks.

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.

2004 has been a volatile and tricky year for investors.  We suspect 2005 will be similar – with the need for defense and nimbleness being critical to investors success.  The current correction may stall when the dollar stabilizes.  The rally coming off of that low will be critical to watch for investors to determine if another leg up can transpire in the global bull move in place since late 2002.

Mark Boucher