Light Participation Amidst Light Leadership

We got yet another 90% up-day as the market moved through 1350 and 50 day ma resistance, helping to confirm the likelihood of at least a bear-market rally to the 1400-1455 zone that we’ve been talking about for weeks.  Yet despite this positive action in the averages, leadership remains quite poor. 

Take a look at our Top RS/EPS New Highs versus Bottom RS/EPS New Lows list at the bottom of the page.  New highs and new lows are plummeting, but Top RS/EPS New Highs still have not risen to 40 or more above Bottom RS/EPS New Lows to signal a decent environment for adding net long exposure to stocks.  We got breakouts in several E&P stocks (HK and FST are favorites) and are starting to get renewed breakouts in some Fertilizers and Ag-related (POT a very close call this week).  Rails like CSX continue to lead and expand breakouts but not substantially.  So far the rally is mostly a sharp correction in some of the biggest laggards of the bull market, such as financials and housing. 

The laggards are doing well, but the leaders are not showing broad strength and marked plurality of breakouts in a handful of leadership groups as would normally be the case at the beginning of a sustained rally.

Chart 1:  Housing stock breakout over 200 ma and new high in relative strength would be positive signal.  Crtsy StockCharts.com

Chart 1 shows one example of this market environment.  Housing stocks led the decline until earlier this year, when they diverged with the market making new lows.  A breakout by the HGX housing index over 158 and over its 200 ma, accompanied by a breakout above the February highs in the relative strength (see top panel of chart 1) of HGX would be a very positive signal that the housing market will put in a bottom later this year, and that housing stocks are no longer weighing on the market.  As the epicenter of problems, this would be very encouraging.

But the market needs to improve not just from its weaker members, it needs to show dynamic leadership to provide a sustainable rally and create substantial investment opportunities.  So far this is still lacking a bit.

E&P, Ags, and Rails so far seem to be topping our Top RS/EPS new highs list (you can access the list daily on www.midasresourcegroup.com).  HK was a close call breakout last week that comes to closest to meeting full criteria, and is in the E&P oil group.  However no valid trades have yet materialized and the number of Top RS/EPS stocks making new highs versus Bottom RS/EPS stocks making new lows (shown in chart at bottom of this column each week and accessible daily on www.midasresourcegroup.com) is not showing 40 new highs over new lows that we would like to label this a good buying environment yet.  So investors should continue to wait, watch the new highs close to or meeting our criteria, and look for a better environment for more valid trades to develop potentially ahead.  Other groups should materialize and develop leadership more thoroughly as well.   Watch E&P (the leading group so far and one that could benefit from continued higher oil prices into the summer possibly), Ags, and Rails now and look for expanding group leadership elsewhere.  The larger the plurality of stocks breaking out in a particular group, the more valid, reliable, and profitable breakouts in stocks meeting or close to criteria are likely to be.

For more than two years in PSL (our monthly newsletter available at www.midasresourcegroup.com) our favorite trade has been being long the Chinese currency versus the dollar in the forex NDF market by shorting the CNY (rolling over 1 month NDF’s).  Chart 2 shows the incredibly consistent trend that we have been exploiting.  With Chinese authorities needing to slow growth, the trend towards them allowing even faster appreciation of the RMB (meaning faster declines in CNY on the forex market) is likely to accelerate.  The only problem with this wildly profitable and consistent trade has been that those without a forex account that trades NDF’s have not been able to participate.  There are some Chinese bond funds like Stratton's Renminbi Bond Fund for those with $100,000 or more to invest (andrewclark@strattonstreet.com for more information), but for many without large accounts or forex accounts at major investment banks or European Private Banks, trading the CNY has been difficult.  The good news is that a recently created ETF with the ticker symbol CNY has been created to allow smaller and non-forex trading investors to participate in at least some of the Chinese currencies appreciation in the stock market.  While the returns of 1 month NDF’s (non deliverable forwards often used for EM currencies) has been MUCH higher than other methods, investors will probably be able to get 10%+ annual gains out of CNY the ETF on an annual basis as the long-term trend towards a rising RMB only accelerates.  Moreover the appreciation of the Chinese currency has not been highly correlated with the movement in the dollar and Euro.  Particularly on setbacks of a few percent or more therefore, we like CNY the new ETF for a place to park long-term investment capital while waiting for the market environment to improve.  Let’s see if the CNY ETF can track the CNY on the forex reasonably well despite NDF premium disparities.

Chart 2:  CNY short, our favorite trade for more than 2 years finally available in ETF.  Courtesy Bloomberg

For many weeks now our long/short strategy was 100% on the sidelines and in T-bills, and it is still very heavily in T-bills right now.  On the long-side PHX should have been stopped out with a small loss, while shorts in TIN should use profits above this week’s highs and shorts in PNK should now take profits.    We suggested lighter than normal allocation to these.  Our suspicion remains that a more bullish bias in breakouts and leadership will develop in the period ahead – but it should be viewed as a trading opportunity only for now.  This past week in our US selection methods, our Top RS/EPS New Highs list published on www.midasresourcegroup.com had close calls in FST and POT on the long-side, no close calls on the short-side, and no valid trades.  This strategy is now only slightly positioned and awaiting more prolific opportunities ahead.

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 “upfuel," 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 www.midasresourcegroup.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). 

The chart below continues to show that now both Top RS new highs (available on www.midasresourcegroup.com) and Bottom RS New Lows are at relatively low levels, and neither has an edge of over 40 versus the other – meaning that the environment is not yet very good for longs or for shorts, though continued improvement in Top RS/EPS New Highs will boost long-side potential ahead.  Let’s wait until leadership and the plurality of breakouts is more prolific before risking much precious capital in this treacherous environment therefore.  If top RS new highs can rise consistently to 40 or higher over bottom RS new lows ahead, we may get a brief environment that allows for some long trades to work as trades.