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

Market Update

It has been a rocky week for stocks. For a change, small caps and tech stocks started by outperforming their large-cap counterparts by jumping higher Monday and Tuesday, allowing the Nasdaq Composite to hit a new 7-year high while the Russell 2000 closed at its highest level ever. Trying to move deeper into record territory Wednesday, the major indexes reversed to close lower after former Fed Chairman Alan Greespan issued a bearish outlook on chinese stocks, stating that they are due for a "dramatic correction". Markets kept moving lower Thursday, as tech stocks were hit by several profit warnings. Investors also reacted negatively to a stronger-than-expected housing report. The Commerce Department reported Thursday that new home sales jumped by 16.2% in April, the biggest monthly gain since April 1993. While this is obviously good news for the economy, it also means that the Federal Reserve will be less inclined to cut interest rates in the coming months and that realization pushed some investors to sell. Stocks were able to regain their footing Friday to recover some of their losses and finish the week on a better note. Please note that the US markets will be closed Monday, May 28 for Memorial Day.

For the week, the Russell 2000 gained 0.76% while the Nasdaq 100 and the S&P 500 respectively lost 0.40% and 0.46%. All 3 indexes rest above both their 50-day exponential moving average (EMA) and 200-day EMA.

For its part, our World Index Ranking portfolio posted a 0.23% loss this week. The portfolio consists of the 5 top-ranked world indexes as of April 27, which marked the beginning of the current 4-week holding period. The World Index Ranking portfolio is being rebalanced today, as the current 4-week holding period is now over.

Our current Buy signal remains in effect.

Trend Timing School

Bull markets

After expounding on the virtues of a hypothetical soft landing (in last week's Trend Timing School article) we would be remiss not to delve into the favorite subject of stock investors: bull markets. Believe it or not, we have been on a mostly uninterrupted bull run since October of 2002, nearly 4 1/2 years. The major U.S. indexes have not seen as much as a 10% pullback this whole time, much less a deeper correction. Highly unusual. The longer this bull run continues the more top calling takes place. Everyone wants to know when this run will end, and there is no shortage of volunteers to predict the date, over and over, until they ultimately have the final top right.

All bull markets are distinguished by wide spread investor optimism, and a general expectation that things are going well and that sustained corporate profits will continue to drive stock market gains. It is a period in which stock prices rise faster than their historical average. Inevitably, at some point investor psychology reverses and a bear market follows. The widespread notion and recognition of alternating bull and bear markets provides the base for trend following techniques, although very few systems attempt to be as long term as would be required to time the bull and bear phases themselves. Interestingly, the very concept of bull and bear markets with their excesses is widely inconsistent with the efficient markets hypothesis held by some (see "The Efficient Market Hypothesis").

While there is an endless number of ways to identify bull and bear markets, we frequently use the common technical analysis method of combining 10-day and 200-day exponential moving averages (EMA). Whenever the faster moving EMA (10) is above EMA (200) we are in a predominant bull market, otherwise we are in a bear market. Another popular method to determine if we are in a bull market is to detect bear markets by defined ranges of losses from a top. Pullbacks (0-10%) and corrections (10-20%) happen during bull markets, but any drop beyond 20% is generally viewed as bear territory. The trouble with all the definitions and measurements for bull markets is that all are trailing indicators. You can only tell the top that ends a bull market long after that top has been achieved. To recognize a top, one has to wait to see the magnitude of the drop on the other side of the top.

Comparing the current bull market and the preceding bear for three of the major U.S. indexes provides good insight into how markets work. The three charts below cover the last 8 years and they clearly demonstrate how well correlated the indexes are: they broadly move up and down at the same time and tend to mark their tops and bottoms simultaneously. In terms of relative performance, everything is skewed by the tech bubble which amplified the Nasdaq's 2000 peak and the ensuing bear market as compared to the broad stock market. Sometimes pictures can be misleading because of varying scales. The Nasdaq's year 2000 peak is so high that it looks like it has gone nowhere in the current bull market, yet in percentage terms it advanced the most.

Bull market - The tale of three indexes







On the other hand, it is also revealing to look at actual performance numbers. Referring to the table below we can compare the actual moves experienced by the same three U.S. indexes. As clearly illustrated in the charts, the tech bubble burst in early 2000 hit the Nasdaq 100 the hardest of all indexes with a loss of over 82% for the bear market. Looking at how the indexes fare today compared to their 2000 highs is great for all investors, but depending on your strategy you will draw different conclusions. The buy and hold investor will clearly see the merits of investing in the Dow Jones Industrials over the long term. After all, it is over 15% above its previous year 2000 high. In sharp contrast the Nasdaq 100 would be the buy and holder's nightmare, still sitting some 60% below its all-time high. The S&P 500 takes the middle road by nearing a new all-time high. Despite having been on a tear lately, the Dow Jones at 85% trails the other indexes in terms of actual gains during this bull market (the S&P 500 and Nasdaq 100 returned 96% and 136% respectively). This is why, contrary to buy and hold investors, Trend Timers will generally prefer the more volatile and stronger indexes such as the Nasdaq 100 and Russell 2000 . It is nice to now have a tool to tell us which of the indexes is the strongest (see FAQ "Are World Index Rankings applicable to investing in the U.S.?" below).

Recent bull/bear performance of major U.S. indexes

	Nasdaq 100	S&P 500	Dow Jones
2000-2002 bear market loss	-82.90%	-49.15%	-37.85%
2002-2007 bull market gain	136.68%	95.98%	85.63%
Today versus 2000 top	-59.52%	-0.34%	15.38%

Generations of investors have proven that attempting to call the top that ends a bull market run is an exercise in futility. Further, since major bull and bear market phases tend to last substantially longer than our Buy and Sell signals, the implication is that we will be buying and selling more than just at the end of the major market phases. We know from history that on average bull markets last 33 months, show a return of 115%, and that they repeat every 5 years. Just because the current bull market is already the longest on record does not make us forget one of the most important rules of Trend Timing, which is to let the trends run their course. We resist our natural tendencies to try to optimize and call the tops and bottoms as they happen and instead let our mechanical Model signal changes in trend as they happen. This is the essence of trend following.

FAQ of the Week

Question: Are World Index Rankings applicable to investing in the U.S.?

Absolutely! We understand that some U.S.-based investors feel more comfortable investing at home rather than in unknown far away markets and it is perfectly fine. The basic principle of following momentum and strength applies to all markets. In the World Index Rankings service we track and rank 27 major world indexes, including 7 U.S. ones (^DJI, ^DWC, ^GSPC, ^IXIC, ^MID, ^NDX, and ^RUT).
In the early days of TimingCube our exclusive investing focus was the Nasdaq 100 (QQQQ ). For diversification reasons it broadened to a portfolio consisting of the Nasdaq 100, the S&P 500 and the Russell 2000. This is before we could tell which market segments were the strongest. The World Index Rankings nicely fills that gap. As a case in point, for most of the current bull market small caps have been strongest, with the Russell 2000 commonly leading other U.S. indexes in the rankings. For the last 6 months however, the large caps as represented by the Dow Jones Industrials have generally outpaced the small issues in the Russell 2000. Being able to know which indexes are strongest let you rebalance every 4 weeks into the strongest ones.

Warm wishes and until next week.

The TimingCube Staff