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

Market Update

After falling further Monday following last Friday's decline, markets turned around and returned to their winning ways for the rest of the week. The main driver behind the move higher was Fed Chairman Ben Bernanke's testimony to Congress on Wednesday. Following last week's hawkish comments by several Fed officials, investors had feared cautionary statements from Bernanke regarding the inflation outlook. Instead, the Fed Chairman said that the economy is sound and that inflationary pressures have diminished. The latest reading on inflation came Friday: both PPI (Producer Price Index) and core PPI matched economists' forecasts and therefore did not alter inflation expectations. In other economic news, housing starts fell over 14% in January. The number was much larger than expected and may indicate that the housing sector has not bottomed yet as previously thought. Please note that US markets will be closed Monday in observance of Presidents' Day. For the week, the Nasdaq 100 , Russell 2000 and
S&P 500 respectively gained 2.01%, 1.37% and 1.22%. All three indexes are still above both their respective 50-day and 200-day exponential moving averages (EMAs).a

For its part, our World Index Ranking portfolio posted a 0.58% gain this week. The portfolio consists of the 5 top-ranked world indexes as of February 2, 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. You should remain invested in the top 5 indexes only if you follow the "Buy and Rebalance" strategy, which remains invested at all times. Please go to our "Strategies" page for all the details.

Our one-month long active Sell signal remains in effect. Even though it has spent the best part of that period in the red, there is no limit in our Model on how long a signal can stay under water. However, there are a number of Cash signals which limit how deep we can go. In addition to our traditional 9% Cash signal, the revised Model we have been operating under since July 14, 2006 introduced another type of Cash signal which detects conflicting trends. We have no way to know for sure which way markets will go, but our Model is poised to signal any change with a Buy or Cash signal at any time. Or, as the model implies, the market will finally take the nose dive it signaled a month ago.

Trend Timing School

The ABC's of ETFs

The explosion in popularity of Exchange Traded Funds, or ETFs, is a small study in the power of compounding interest. In this case, it's the interest of investors who recognized the potential and advantages of adding these investment gems to their portfolios.

Right at the turn of the century, ETFs started to draw savvy investors. In 1999, there were 30 registered ETFs in the marketplace. By the end of 2005, 212 ETFs with combined assets in excess of $296 billion were officially listed according to Morningstar, as compared to $1 billion 10 years earlier.

ETFs are index funds listed on a stock exchange. Like mutual funds, they hold shares in a broad spectrum of companies or commodities. But, unlike mutual funds which are typically priced once per day at the close, ETFs can be bought or sold at any time during the trading day just like any other stock. What's more, they are competitively priced and their fees are low. They are not subject to the "frequent trading rules" that brokers increasingly enforce on mutual funds.

For our money, ETFs are the most practical and economical investment vehicles for implementing a trend following system. ETFs are extremely convenient and easy to use. They can be bought and sold exactly the same way as any stock using identical techniques such as limit and stop orders, short sales and margin trading. What's more, a growing number of ETFs now have options, or contracts which convey the right to buy or sell shares at a set price before a specific date.

But not all ETFs are ideal for trend following. Closed-End Funds (CEFs) which are frequently lumped in the general ETF category have a fixed number of shares. Their price is influenced by the demand for the fund itself, which means it can be considerably different than the price of the underlying assets. For a trend following investment approach which follows the broad stock market, fixed-income funds that pay interest by investing in various debt instruments like bonds or those that invest in currencies don't work well either. The third category to avoid is ETFs that invest in commodities like oil and gold, currencies or interest rates, because these will not generally correlate well with stock market based trend we follow.

So that leaves us with equity index ETFs, our favorites for that portion of your portfolio devoted to trend following. These are diversified, transparent, liquid and affordable, all of which appeal to a trend following investor.

Diversification
As the name indicates, equity index ETFs track a particular stock market index by investing primarily in the securities that constitute that index. When you buy an ETF share, you buy the entire basket of stocks making up the index. That's automatic diversification. How much diversification you actually get varies greatly, because while some indices represent broad markets -- such as the Nasdaq Composite -- others are extremely narrow.

There is an index and an ETF for just about every sector, type and geography of the market. Some track industry-specific indexes, like the SOXX index, a proxy for the semiconductor industry, and the Dow Jones Utilities, which only holds 15 large utility companies. Others differentiate themselves by value or growth company type or the size of their constituent companies, (small-, mid- or large-cap). There are also many region- or country-specific funds.

But keep in mind it is easier (and we believe a more accurate gauge) to observe trends in broad market funds. The more narrow and specific a fund is, the less likely it is to exhibit good correlation with the broad markets and with a trend following model.

Transparency, predictability and safety
By definition an index fund has the clearly-identified objective of tracking a market index. There is no question as to what it invests in or what performance to expect in relation to the index, unlike actively-managed Closed-End Funds and mutual funds. ETFs are highly-regulated and scrutinized, so they're less prone to all the illegal practices and fraud that have plagued the mutual fund industry. The market risk of an ETF -- or how much you can lose -- is identical to the index it tracks and the type of underlying assets. Sector funds or emerging market funds can present extremely high risks. There is also a new generation of short and leveraged ETFs that appeared for the first time this year which let you approximate the effects of shorting the market and/or investing on margin. For example, there are funds which have as daily objective to achieve twice or twice the inverse of the performance of the index they track, with all the added risk that entails. Still, more and more advisors and money managers who follow traditional investing methods are looking at such ETFs as a hedge for portfolios.

Liquidity
Frequently viewed as a major advantage of individual stocks and mutual funds, liquidity varies widely from one ETF to the next mostly as a function of how long the fund has been in existence and how broad or specialized it is. Normally, an investment that is thinly traded with high spreads and volatility, is considered illiquid... a bad thing if you are a traditional investor.

In contrast, the way ETFs work makes them immune to certain aspects of illiquidity. Contrary to popular belief, since ETF shares can be created and unwound in real time, the liquidity of an ETF is not related to its daily trading volume but rather to the liquidity of the stocks comprised in the index.

In addition, ETFs typically have small spreads (generally less than 1%) because market makers, specialists and arbitrageurs all interact and compete to effectively flatten the premiums and discounts to fair market value.

Still, despite these advantages, we highly recommend sticking with ETFs that are highly liquid, particularly if you are going long and short in your trend following strategy. Regardless of how liquid the underlying companies are, an illiquid ETF makes it nearly impossible to short because your broker will not have any shares to loan you. And in the event he does, he has the right to "call away" those shares at any time, which most likely will be bad timing for you.

Cost
While you still have to pay transaction fees (commissions) to your broker when you trade ETFs, they are much more economical to own than mutual funds. ETF expenses are, on average, more than seven times lower than both actively managed and index mutual funds. As an example, a large popular fund such as QQQQ has an annual expense ratio of just 0.18 percent compared to an average expense ratio of 1.4 percent for mutual funds.

Despite having to pay taxes on the capital gains on a trade, ETFs offer other significant tax advantages. Because of a loophole in the regulations, the purchases and sales of underlying securities by institutional investors to create or unwind ETF shares are defined as "in-kind trades." That means they're not taxed like the trades executed by a mutual fund manager. For some mutual funds, such taxes can amount to more than 10 percent of the fund's assets per year.

Despite our enthusiasm for ETFs, this is not a blanket endorsement of the industry. The pitfalls are definitely out there. We are the first to say that all ETFs are NOT created equal and we strongly recommend staying with the most popular and largest of the funds, in particular the ones that track the broadest market indices.

FAQ of the Week

Question: How do ETFs and mutual funds compare?
As the two primary investing choices for Trend Timers, we have been comparing ETFs and mutual funds for years. Due to the rapid evolution in the ETF industry the competitive landscape has been shifting, clearly in favor of ETFs.

There are many types of ETFs and mutual fund products, and it is hard to lump them all in the same bag for comparison. In order to focus on the type of funds we require to implement our strategies we have narrowed our comparison to ETF families which offer inverse, double and double inverse funds, i.e. ProShares, and matched them up with the bull/bear mutual fund families which offer the same choices (Direxion, ProFunds and Rydex).

Not too long ago (see "Am I better off using ETFs or mutual funds?") ETFs still suffered in simplicity from requiring shorting and margin investing to implement all four startegies, which also ruled them out of any qualified retirement account. With the advent of short and leveraged ETF products such limitations no longer exist. The only catch is that there are still only fairly few choices in that category. The table below provides a quick assesment of how ETFs and mutual funds compare.

	ETFs	Mutual funds
Simplicity	Simple fund buy/sell	Simple fund buy/sell/exchange
Retirement accounts	All 4 strategies	All 4 strategies
Trade execution	Continuous while market open	At market close
Costs	Low expense ratio (0.95%)	High expense ratio (1.25-2.00%)
Index tracking	Good But leveraged funds can vary significantly*	Good But Leveraged funds can vary significantly*
Performance	Leveraged funds can outperform or underperform*	Leveraged funds can outperform or underperform*
Liquidity	High	Low to Medium
Trading restrictions	None	Brokers enforced frequent trading rules

* To understand the idiosyncrasies of leveraged mutual funds, read the November 28, 2003 FAQ of the week.

Warm wishes and until next week.

The TimingCube Staff