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

Market Update

This week, to the cheer of investors, the market reversed the tempo to two steps back and three steps forward. The action began very subdued as investors showed understandable caution in the wake of the previous week's drubbing. Alas, Tuesday managed to turn the drubbing into a rout, with major stock indexes torpedoed by another big drop in long bond prices and surging yields. In retrospect, mid-day statements by Alan Greenspan did far more harm than good (see the Trend Timing School article below for details on his speech).
A well orchestrated series of positive economic reports was all it took to put the bulls firmly back at the helm. On Wednesday, the Commerce Department's higher than expected May retail figures and the Fed's "Beige Book" revealing healthy growth with no inflationary pressures combined to reverse the market mood. For good measure, a mild PPI (Producer Price Index) reading on Thursday and a tame Core CPI (Consumer Price Index) on Friday motored markets upwards on impressive volume, albeit assisted by quarterly option expirations.

The Nasdaq 100, S&P 500 and Russell 2000 respectively gained 1.90%, 1.67% and 1.54% on the week. Market technicians will once again admire the resiliency of the 50-day exponential moving average (EMA) as a support zone in the current rally, as all major averages smartly rebounded from it earlier in the week. All 3 indexes remain above both their 50-day and 200-day EMAs.

The 5 top-ranked indexes in our World Index Ranking sample portfolio handily outperformed the broad U.S. stock averages this week by advancing 3.04%. Worthy of a special mention is a big rebound from Brazil with its ETF (EWZ) gaining 7.59% for the week. The sample portfolio was last rebalanced on May 25, which marked the beginning of the current 4-week holding period.

Our current Buy signal remains in effect.

Trend Timing School

Global liquidity glut

This week we continue with our review of the primary drivers behind the longest uninterrupted equity bull market in recorded history, and following last week's exposé on interest rates we now examine the excess global liquidity which has been sloshing around world markets.

The word liquidity in these pages is most frequently used in its investment meaning which generally refers to the average daily volume of a stock or fund as a measure of how readily it can be converted to cash without affecting its price. Instead, in this article liquidity is the term broadly defined by economists as meaning the supply of money.

The primary sources of global liquidity are:

• Accommodative monetary policies
• Low interest rates
• Carry trade
• Build-up of excess foreign reserves (around the world, not the U.S.)
• Exploding savings in Asia
• The wealth factor of rising prices of homes, bond markets and equity markets

Arguably, the largest liquidity contributors are the collective monetary policies of major central banks.

The seeds of the current liquidity glut go back a long time. Following World War II in 1945, the so-called Bretton Woods regime was based on a gold-backed dollar, and liquidity was not much of a topic of discussion. This all changed as U.S. fiscal deficits from overseas spending, i.e. the Vietnam War, caused a massive drain in U.S. gold holdings, leading President Nixon to abandon the dollar's peg to gold in 1971. The ensuing decade of stagflation led to monetarism, a theory developed by conservative economist Milton Friedman. He argued that inflation is primarily caused by government printing too much money and his "Quantity theory of money" advocated a fairly steady supply of money, with only slight yearly increases to allow for the natural growth of the economy, in order to solve the problems of inflation, unemployment and recession. These theories captured the fancy of politicians who helped craft the more accommodative monetary policies which came with the supply-side revolution of the 1980s.

Monetary policies are what central banks (e.g. the Federal Reserve in the U.S.) do to control the money supply in efforts to manage demand. Monetary policy involves open-market operations (the Fed buying or selling assets such as freshly printed dollars in order to influence yields and prices), setting reserve requirements for banks and other lenders, and changing the short-term interest rate (the Fed rate or Discount rate). Monetary policy goes hand in hand with fiscal policy which comprises public spending and taxation by the government.

President Ronald Reagan, by promising across the board tax reductions, was the most ardent cheerleader of supply-side economics, which for a time became known as "Reaganomics", and later as "voodoo economics". Opponents of supply-side economics later dismissed the entire project as a complete failure and nothing but a disguised attempt at reducing marginal tax rates on upper income brackets. They point to decreasing productivity under supply-side policies, the explosion in deficits and the conversion of price volatility to currency volatility as irrefutable evidence that it does not work.

Regardless, printing presses have remained front and center in politician dreams and deeds. Owing to extremely accommodative monetary policies in the U.S., Europe and Japan, especially since 2002, there has been an overabundance of liquidity which has been chasing assets around the globe. There is little doubt that these trillions in search of returns have significantly contributed to well-performing asset classes, including rising world equity prices, low long-term risk-free interest rates, as well as rising real estate prices. Exactly how much new cash the U.S. government injects into the system became harder to decipher since the Federal Reserve Board ceases the publication of the M3 monetary aggregate in March of 2006, but few observers doubt that the key index is hidden from public view in order to allow liquidity to be pumped at will in secrecy.

Pervasive low interest rates have been a global source of easy money by promoting lending and investment, and they caused a global credit bubble which is inflating the price of everything. For a quick review of the mechanics, causes and effects of inflation, read the eponymous Trend Timing School article dated January 20, 2006. With its long-standing zero-interest rate policy Japan is a prominent example of how liquidity can be injected into the system through artificially low rates. Note that Japan's central bank has recently raised rates for the first time in 6 years, from 0% all the way to a stunning 0.25%, which will not help cool the situation much. In the so-called Yen carry trade, a speculator borrows money in Japan for no or very low interest and invests it in countries and instruments offering a higher return, for example U.S. bonds or stocks. The difference is pure profits, and the only risk is that the Yen gains value, which so far it has not as just this week it reached the lowest level versus the U.S. Dollar and all major world currencies since 2002.

Such easy credit has also spurred an avalanche of leveraged buy-outs financed in record numbers by private equity firms gambling with other people's money, paying increasingly outlandish prices for companies using very little of their own money.

Last but not least, the rampant trade surpluses in Asia have led to the accumulation of trillions in foreign exchange reserves in many of these countries and, there is nothing in sight to change the tide. While much of these reserves are held in U.S. Dollar denominated bonds, there have been growing efforts by most governments to diversify and better invest these reserves. Economic success in Asia is also rewarding exploding working middle classes who suddenly have money for discretionary spending in addition to expanded savings budgets.

Just when you start to believe these trends will continue forever we are seeing some early signs that things may be changing, that the air might be begining to leak out of the global credit bubble:

• Long interest rates have started going up
• Foreign central banks have begun hiking short term rates
• The leverage buyout boom appears to be about to go bust
• Housing foreclosures jumped 90% in May from a year ago

These changes are expected to ultimately cause consumers to pull back on their debt-financed consumption, which in turn will affect the economy and the stock market.

Just this Tuesday, former U.S. central bank chief Alan Greenspan (who had us all fooled into believing he was retiring... ) warned that the boom in global financial market liquidity was near a turning point, sparking a one-day sell-off in the stock market. "Even though liquidity will continue to increase, its rate of growth will slow," he said. Greenspan traced the current period of economic prosperity to the fall of communism, with China leading other developing countries and generating growth and "well above normal" savings rates which have been driving down global long-term interest rates. Once liquidity growth peaks, however, long-term interest rates will start to move back up and as a result, "a lot of market value disappears," he added.

With much of the drive behind the continuing bull market coming from low interest rates and abundant liquidity, we are constantly reminded that it is increasingly vulnerable to reversals in both, and further motivation for us to watch the market for the major trend changes which lie ahead.

FAQ of the Week

Question: Will you expand the World Index Ranking system to other ETF types?

Many of our subscribers have become ardent supporters of the investment approach embodied by the World Index Ranking system, specifically, that by targeting the strongest markets one can achieve substantially higher returns than by staying invested in the same market(s). Our momentum seeking methodology has not only proven effective when applied to geographic index ETFs, as demonstrated by the returns of the World Index Ranking system, but our research also reveals that it can be adapted successfully to ETFs of all types, broad and specialized.

The TimingCube service is all about following the broad market trend by investing in the major stock market indexes and their ETFs. We have repeatedly demonstrated that major World markets have generally well correlated market cycles, and applying the same long-term timing signals to them has proven effective. In addition to the timing component, during Buy signals we have the complementary targeting of the World Index Ranking which tells which of these broad markets are strongest.

The variety and degree of specialization of index ETFs has exploded in recent years offering individual investor and professionals alike a vast array of potential investments. At last count, we identified nearly eighty distinct types of index funds, focusing on everything from country and regional groupings, to large/mid/small/micro cap companies, industry sectors, commodities, precious metals, currencies, and bonds. Trouble is that many of these specialized fund categories are not well correlated with the broad market trends tracked by our Trend Timing approach, and accordingly, there are no plans to expand the TimingCube service to encompass such unrelated ETFs.

But do not despair, help is on the way. The TimingCube founders are getting close to launching a new ETF ranking service to help investors target the strongest ones and stay clear of the weak. You will hear about it first, promise.

Note from the editor: ETFTide, the new ETF ranking service, has since been introduced (see Weekly Update dated July 13, 2007).

Warm wishes and until next week.

The TimingCube Staff