Shift in leadership to more downside capitulation developing?

One can often discern what is happening in the market by closely watching what is happening in our long-short strategy.  Since our last update, two of our longs were stopped out on break-even trailing stops (AGU and MON), one new long was stopped out on original ops (NE), and our short LVS plummeted by over 30% in our favor.  Clearly the downside has been where the action is in the market.

Moreover the fact that longs were all stopped out is a concern for the  2-way market environment that has developed since mid-March.  We are now seeing some former leading groups like rails, steels, materials, and even some energies, start to breakdown and underperform on a short-term basis, as they capitulate to a bear market phase.  Confirming this action has been sector rotation.  The leading relative strength groups have shifted from basic materials and energy to staples and utilities, something that historically takes place in the transition to a clear bear market phase.  These leaders aren’t rising, their just falling less, for the most part.  Therefore our thesis is that we are starting to shift from a two-way market to more of a clearly negative one.  Shorts, shorting weak groups versus the market, or buying defensive groups versus the market short should be the primary ways of playing this market in such a phase – and with less allocation than even earlier, as this is the most dangerous phase of the market.

Let’s take a bit close look at our short position in LVS which has done so well recently.  First of all, LVS has fallen nearly 40% since our short-sale signal, a substantial drop.  It is in the gaming group, one of the leaders on the downside.  When a stock falls sharply, one should look to longer-term charts for areas of potential major support that are likely to lead to corrections in the steep down-trend.  Chart 1 shows LVS weekly having major support at the 29-30 zone.  We suspect this is where LVS could launch a more meaningful correction, off of this major support zone.  Therefore we would look to take at least half profits as LVS gets close to this support zone.  In the meantime we will continue to aggressively lower trailing stops to lock in more and more profits as LVS moves lower.  More patient traders could use the down-trendline in chart 2 as a trailing stop tool.  We’ll lower stops to around 46.50 via our strategy and see if LVS can move down further ahead.  Substantial short-term moves like this can happen on both the short side and the long-side – and this one short-hedge helped keep the damage from some long stop outs from hurting our portfolio in this treacherous bear market.

 
Chart 1:  LVS falling swiftly – look to long-term chart for potential next major support zone.  Courtesy Bloomberg

 
Chart 2:  Lower trailing stop to lock in huge profits and let LVS ride if it falls to 30 support as suspected.  Crtsy Bloomberg

We are also watching for a move by GDX over 51.5, confirmed by the dollar index DXY falling below 71.80, confirmed by the Gold ETF GLD closing over 94.15 to signal that the next wave down in the dollar has begun and the next wave up in gold and gold stocks is underway.  Such should be taken as a buy signal in gold or gold stocks.  The ECB action today, raising rates but suggesting this might be the last hike, gave the dollar a boost, at least temporarily.  We’ll see how long it lasts next week.

The market is starting to grow in downside intensity.  We’re close to getting 5 days in a row of Bottom EPS/RS New Lows being 40 or more over Top EPS/RS New Highs (see www.midasresourcegroup.com).  The Dow has made new bear market lows and the rest of the major indexes are likely to eventually follow.  The Fed is stuck in a box where it cannot raise rates because that would kill banks that are already on the ropes, but it cannot lower rates because inflation is flaring from higher oil and food prices.   Until either oil and food prices correct sharply or the economy and stocks soften significantly further, all the Fed can do is try and jawbone the dollar higher while doing nothing – and that is unlikely to calm nervous markets smelling a deeper recession than previously imagined. 

Our long/short strategy since our last update was stopped out of AGU and MON on break-even trailing stops, and out of NE for a full loss to original ops, while our lone short-sale LVS plummeted to our benefit(now use 46.5 trailing stop to lock in big profits.  Since our last update we got close calls on the long side in MUR and WLL, with close call short sales in M, HTCH, and SWS.  Check out www.midasresourcegroup.com for daily listings of Top EPS/RS New Highs and Bottom EPS/RS New Lows to make sure you catch all these.  As the chart at the bottom of the page illustrates, bottom relative strength new lows are shooting for dominance over top relative strength new highs here, in what we would describe as a market potentially transitioning from a two-way downward biased market to a downward dominated one experiencing some capitulation.

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 shows that Top RS new highs (available on www.midasresourcegroup.com) are now below bottom RS/EPS and have been 40 over for four days – nearly signaling a downward dominant market which would be signaled by another day Thursday with Bottom EPS/RS New Lows 40 or more over Top EPS/RS New Highs.  Shorts and defense should be utilized!