Signal Type	Trade Date	Index	Return since issued
		Nasdaq 100
		Russell 2000
		S&P 500

Market Update

Stocks retreated again over the 5-day span, giving back their gains of the previous week. The major averages moved modestly lower Monday, dragged down by weakness in the financial sector. Stocks then plunged Tuesday after the Institute for Supply Management released its report on service activity for January: the ISM's service index dropped below 50, a level that indicates that the service sector, which accounts for about two-thirds of the economy, contracted in January, raising fears that a recession is around the corner. Adding fuel to the fire, a Fed official commented that the risk of inflation is substantial and that the odds of a recession have climbed. Not surprisingly, investors reacted by selling heavily, which resulted in the biggest daily loss for the S&P 500 in almost a year. The major indexes tried to stage a rebound Wednesday but eventually reversed lower after the Philadelphia Fed president also made hawkish comments on inflation, casting doubts on the ability by the Federal Reserve to continue its rate-cutting campaign. A disappointing earnings report and weak outlook from Cisco initially sent stocks lower Thursday, but the market righted itself to close the session with modest gains. A good showing by tech stocks helped the Nasdaq 100 to a 1% gain Friday. Other major indexes did not fare as well and posted more losses instead, pressured by ongoing weakness in financials.

The Nasdaq 100, Russell 2000 and S&P 500 posted respective losses of 4.39%, 4.32% and 4.60% on the week. All three indexes remain located below both their 50-day and 200-day Exponential Moving Averages (EMAs).

For its part, our World Index Ranking outperformed its U.S. counterparts this week with a loss of only 0.97%. The portfolio consists of the 5 top-ranked world indexes as of February 1, which marked the beginning of the current 4-week holding period. Please note that since we now have an active Sell signal, the World Index Ranking approach calls for selling your holdings if you follow the "Long Only" or "Long and Short" strategy. Only if you follow the "Buy and Rebalance" strategy should you remain invested in the top 5 indexes, as the strategy calls for staying invested at all times. Please go to our "Strategies" page for all the details.

Our current Sell signal remains in effect.

Trend Timing School

Heavy weather

Anyone watching the news out of Washington lately can easily see that Iraq has been overtaken by the faltering economy as the top issue for politicians. Maybe it has to do with the fact that recent polls show it weighs most heavily on the minds of voters. Naturally, the sitting administration is never eager to reveal bad economic news. For the longest time there had been complete denial, with the housing crisis and credit crunch to remain nicely confined to the sub-prime mortgage niche, and exploding energy prices having no significant impact on the economy. More recent data has a growing number of economists convinced that the U.S. economy is in for heavy weather and that indeed it has already toppled into a recession for the first time since 2001.

Recessions are hard to detect as they unfold, and the official government measure consists of two consecutive quarters with contraction of economic activity. Optimists point out that gross domestic product (GDP) grew at 4.9% in the third quarter of 2007 and was still growing in the fourth quarter. They fail to point out that going from 4.9% growth to 0.6% in one quarter as reported by the Commerce Department is equivalent to coming to a screeching halt. Many now call it a stalled economy, and some economists believe it may actually be shrinking in the current January-to-March quarter.

Consumer spending is the biggest single factor in the economy and this explains why consumer confidence is a critical indicator. Contributing to consumer anxiety is the deepening housing slump which is shrinking the value of most people's largest asset: their home. Even homeowners not directly affected by raising interest on sub-prime or other adjustable mortgages are feeling less wealthy. A 20% loss on their buy and hold stock investments does not help either.

A report by the Labor Department last week indicated a net job loss in January for the first time in more than four years. Earlier this week, more alarm bells went off when the Institute of Supply Management released data revealing that employment in the service sector had declined for the first time in five years. Importantly, the survey covers sectors like retail, transportation and health care, not just hard hit finance, real estate and construction. A weakening job market is what consumers fear the most, and this is reflected in recent consumer confidence indicators. Although not factored in the government's favorite core CPI inflation indicator, creeping food and energy prices have been putting a real squeeze on consumer budgets.

The direct effect, maybe more tangible than the various barometers of consumer confidence, is the fact that major retailers like Wal-Mart have reported dismal sales figures for January. So, accepting until further evidence is presented that we are in a recession; the question on everyone's mind is what can the government do to keep it short and shallow?

For months now the Central Bank has been injecting liquidity into the financial system in an effort to combat the effects of the credit crunch. Many long time Fed observers have not failed to notice their panic three-quarter of a point rate cut which was aimed squarely at supporting the stock market on January 22^nd. In view of the several months it takes for lower interest rates to work through the economy, there was very little economic rationale for the Fed to accelerate a rate cut by a few days before their normally scheduled meeting or to applying the largest cut in a quarter century. Besides clearly showing the world how spooked they are, not a good thing if you intend to instill confidence in the system, the move also establishes a dangerous precedent of linking the Fed's success to their short term impact on the stock market. Still, despite some tough words on inflation everyone now knows the Fed will do everything it can to support the economy, and the stock market.

Rather than risk further election-year backlash over the deteriorating economy, Congress quit their partisan bickering and approved an economic aid plan which President Bush indicated he would sign. There is little doubt that the $170 billion cash infusion, mostly in the form of tax rebates for low- and middle-income households, senior citizens and disabled veterans will give a one time jolt to consumer spending, but most observers believe President Bush over promised when he said the economic stimulus plan would keep the economy healthy and create more than half a million jobs by the end of 2008.

For the sake of completeness we need to mention a not negligible school of economists and market historians who believe that governments and their fiscal machinations actually create most recessions in the first place.

Regardless, stimulating the economy is not free and is not guaranteed. One of the big dangers of continued interest rate cuts, which went as low as 1% during the last cycle, is that the U.S. dollar risks becoming a funding currency for the "carry trade", which consists of borrowing in a weak currency with low interest rates and investing in a currency with higher rates. If this happens, the dollar is likely to weaken even further as it will become increasingly difficult to convince foreign investors to keep financing America's deficits and a failing currency.

The big question is how long and how deep this recession will be? We have become used to economic expansions which last much longer than average (the March 1991 to March 2001 was the longest in recorded history), and shorter recessions. Some economists point to historical averages to predict that this recession should last an average of 11 months, using post World War II statistics. These numbers conveniently leave out the three depressions which occurred during the twentieth century. A depression is a recession which is of longer duration, deeper in terms of economic contraction and unemployment rates, and which affects a larger percentage of industries. The longest lasted 43 months (August 1929 to March 1933), saw GNP drop by 32% and unemployment at up to 25%.

Some say that thanks to heavy government interventions and stimulations a more realistic middle-of-the-road scenario is lower economic growth, but not necessarily contraction, accompanied by rising inflation. This is called stagflation, an economic condition which economists, politicians, and most everyone else fears (see the FAQ of the Week below for more details).

We certainly do not wish for a recession or the stock market upheaval that will accompany it, but now that much of the evidence points to one, we need to know what we can expect. Based on all the data available so far we cannot predict which type of recession we are going to have and neither can anyone else. What we know is that the stock market has been on a downtrend since late last year and volatility is up to levels not seen in five years. While such conditions continue, our trend following approach should prove most effective. It is precisely because of turbulent periods like these that trend following and mechanical directional models such as TimingCube have been invented.

FAQ of the Week

Question: What is stagflation?

A country's economy is said to be in stagflation when experiencing prolonged periods of no or slow economic growth (stagnation) combined with a rise in prices (inflation). While stagflation periods may not be classified as recessions (which require economic contraction), they are bad situations to be in. With relatively high unemployment keeping a cap on salaries and sharply rising prices, consumers get squeezed. Except for a couple of recessions, the seventies were dominated by stagflation.

The stock market does not do well during periods of stagflation and investors are well advised to navigate treacherous markets with extra caution. A market following system like our Trend Timing approach should do well in exploiting the severe downdrafts and increased volatility which are common during such times.

Warm wishes and until next week.

The TimingCube Staff