When in doubt, stay out

One of my favorite trading and investing rules is one of W.D. Gann’s which goes, “when in doubt stay out, and don’t get back in until you’re sure.”

A favorite analogy story I often tell is of the small Columbian village that had a dirt road airport without lights but needed an emergency night-time landing. Every person in the village who had a car was called upon to drive it to a specific place and then aim at a slightly different angle than the other cars, all with headlights on. By combining many points of lights together the village created enough light for the plane to land.

This rule and analogy point to what we’re striving to do in the markets all the time. First we’re only investing when we’re very sure of the scenario, trade, or investment vehicle that we’re investing in -- otherwise we stand aside and earn interest. Second we apply many points of light, many different methodologies of market analysis and try to find periods and asset-classes and sectors where many different analyses point to the same trend developing in order to build reliability.

This year we’ve been talking about macro policy more than at any time since the 2002-2003 period when we emphasized the most massive concerted global policy stimulus in the post WWII era and what effect that was likely to have on markets. Macro analysis is one point of light we use frequently to give ourselves an edge – and at times it is nearly mandatory to investment survival. We also nearly always talk a-lot in these columns about breadth, plurality, supply-demand volume analysis, and reading what the majority of the market is doing. These are other points of analysis light that can help us see through the thick fog of an unknown future.



Our certainty and therefore allocation tends to be more aggressive when several points of light all lead to the same trend, and we’ve found a good risk/reward instrument for investing or trading in that trend. But likewise, when few points of light point definitively in the same clear direction, our certainty and allocation should be less aggressive. Many traders and investors make the mistake of not understanding how it is just as critical to pinpoint times to be mostly on the sidelines as it is to pinpoint times to be heavily invested. When a period of uncertainty develops, many novice traders keep trading at the same level of allocation and aggressiveness as during times when it is fairly easy to make money in a strong clear reliable trend. Sometimes they may get lucky and do well, but usually such environments lead to high volatility and big drawdowns. Pinpointing difficult environments is key DEFENSE for investing.



Currently I would rate the macro environment as not highly reliable (except perhaps for bonds and (TLT | Quote | Chart | News | PowerRating), which are likely to beat cash as the US slows down and have broken out of a base recently). The US economy is slowing down. Some measures of housing in particular are falling at levels that have usually indicated a recession ahead. Likewise some monetary variables like monetary base growth, the ratio of lagging/coincident indicators, and the 2/10 yield curve have reached levels that have usually preceded recessions or substantial slowdowns in growth. Normally such a combination of indicators suggesting a sharp slowdown will lead to slower than expected growth ahead and a focus by markets on the risk of recession, meaning some volatility and downside for stocks. On the other hand if the rest of the economy can hold up fairly well to a housing slowdown, and if inflation gauges begin to turn down again quickly, the US economy may well witness only a mild growth slowdown, and markets may be able to look through the weakness and focus on the likely end of rate hiking ahead. From a macro viewpoint, the outlook is not very clear or reliable in the intermediate-term. And there are HUGE potential risks from geopolitical considerations.



Similarly, the internal market breadth, volume, and plurality indications are not clearly definitive. The progress of advance/declines and NH/NL’s has not been as substantial as would normally lead a sustained advance in the market as a whole. Our own Top RS/EPS new highs have not led to a broad number of stocks breaking out and meeting our criteria for possible buy candidates. Nor have new lows or downside action been significant enough for us to suspect a major down wave is imminent. Supply and Demand measures of volume are not clearly directional either. Some groups are trending higher, and some, like housing related groups and some retails, are trending clearly down.

In relation to these critical points of light, there is no clear signal and no clear direction that I can discern. In other words, the outlook is unclear, we’re not sure, and when in doubt we should mostly stay out of the markets. As much as anxious traders and investors hate to hear that, it is the best advice I can give for the current environment for investors. Remain defensive and heavily sidelined until the environment clearly improves and the outlook for a strong trend become clear.



Investors should continue to skeptically let market action be the guide. Strong rallies in the major averages accompanied by high volume to create a couple more follow-through days would be the first sign of more upside ahead. The real excitement may not come until the breadth of Top RS new highs starts to expand broadly and stocks meeting our runaway up fuel criteria begin to break out with some plurality. Until then, we still suggest keeping your powder mostly dry. We continue to suspect that breaking above 1320-27 and making new highs will be difficult for the market to do unless better volume and breadth materializes. We continue to regard this as a TREACHEROUS ENVIRONMENT where CAPITAL PRESERVATION SHOULD BE PARAMOUNT. Don’t allocate heavily to anything that doesn’t scream at you.

Sometimes the sidelines are the best place to be. We suspect we’re still in one of those times. Conflicting forces continue to grow, and high odds sustainable moves don’t appear likely to materialize just yet. Until they do, we suggest mostly keeping your powder dry and watching events transpire closely.



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.

Our US selection methods, our Top RS/EPS New Highs list published on TradingMarkets.com, had readings of 35, 23, 20, 26 and 14 with 9 breakouts of 4+ week ranges, no valid trades meeting criteria, and no close calls. This week, our bottom RS/EPS New Lows recorded readings of 11, 8, 9, 13 and 11 with no breakdowns of 4+ week ranges, no valid trades and no close calls. The “model” portfolio of trades meeting criteria has some time back exited all positions and is 100% in cash.

Mark Boucher has been ranked #1 by Nelson's World's Best Money Managers for his 5-year compounded annual rate of return of 26.6%.

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".