Bollinger: A Signal from Zweig

06/25/2004 12:00 am EST

Focus:

John Bollinger

President and Founder, Bollinger Capital Management

John Bollinger has an exceptional ability to see into a maze of technical and fundamental investment data, and present clear-cut and unhedged advice for both traders and investors. Here’s the latest advice from his Capital Growth Letter.

"We have had a pair of important signals from the stock market. We call these Breadth Thrust signals and they occur when up volume on a given day is greater than 90% of up volume plus down-volume. The first signal occurred on May 25 and was a near miss at 89.1%. If that were all there was I would have walked away without much positive conviction; it was, after all, a near miss. But then on June 6 we got an even stronger signal, up volume was 91.6% of up+down volume that day. That made two Breadth Thrust days in a short span and that is very bullish. The well-known technician, Marty Zweig, first outlined this indicator in his 1986 book Winning on Wall Street . He noted that ‘ ...the 9-to-1 up day is the most encouraging sign, and having two of them within a reasonably short span is very bullish. I call it a double 9-to-1 when two such days fall within three months of one another.’  Zweig found 12 such double 9-to-1 signals between 1960 and 1985. Three months later the market was up 11 out of 12 times. Six months and one year later it was up 12 out of 12 times. That's a pretty good track record and one we are not likely to gainsay. For us this Breadth Thrust signal amounts to an all clear for the stock market suggesting higher prices ahead.

"Meanwhile, our best guess is that the money will not be made in the indices, but that the real money will be made in sectors and groups. Right now the top three sectors are Transportation, Energy, and Industry. These are all heavily economically-sensitive groups and their strength argues strongly for a better economy. One of the more interesting things to do on a down day is to look at the winners and two stand out in recent action, General Electric (GE NYSE) and Microsoft (MSFT NASDAQ). Both sport interesting patterns and are worthwhile speculations. We are adding these issues to the core portfolio. We think that these are tried-and-true stocks in investors' minds and that they are using them as an ‘easy’ way of getting back into the market. In our view this is a trade, not a long-term position, but we shall see.

"In addition, we are adding a 10% portfolio allocation to international stocks, by initiating equal positions in the iShares UK (EWU ASE), and iShares Japan (EWJ ASE). Of all of the international markets we follow, the UK market is the one that has the most leading characteristics for our own market. I tend to worry any time there is a serious divergence between the two. I'd note that the rotation of the UK to the top of the iShares momentum list strikes me as another positive factor for the US markets. It is another bit of evidence that we aren't ready quite yet to transition to a cyclical bear market. Another area of relative strength is Japan, which we regard in a similarly positive fashion.

"Quietly, almost without anybody noticing, short-term interest rates have been sneaking up. The rise has taken short-term rates from below the Fed Funds target to above it. This suggests a move from a regime of accommodation to a regime of monetary stringency. This is a sea change. Fed policy has been involuntarily and irrevocably changed; eventually the Fed will have to acknowledge the change. Given the dynamics we see in the market place we think this change in policy will last years and carry us to a dramatically higher interest-rate environment. We have transitioned from an environment in which deflation was the risk to a market in which inflation is the risk. However, it is not yet fully evident to most because the Consumer Price Index is severely understating inflation. In any case, inflation is out of the bag. In order to avoid deflation, the Fed elected to pay the piper and the piper's name is inflation. For investors this means assets that are hurt by rising interest rates must be avoided. We have also taken a position in the ProFunds Rising Rates Opportunity Investor Fund (RRPIX). You may also consider the Rydex Juno Investor (RYJUX). Both of these funds move in the direction of interest rates, that is the net asset value of the funds goes up when interest rates go up precisely the opposite of the 'normal' inverted relationship everyone knows and loves."

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