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

Market Update

Stocks did not move much this week despite the fact that we had plenty of volatility along the way. With worries about the possible failure of hedge funds due to subprime mortgage woes still present in investors' minds, the major averages moved lower the first two days of the week. Stocks then posted a sizeable rally Wednesday, led by technology stocks after Oracle released a better-than-expected earnings report and issued a bullish outlook for the current quarter. Semiconductor stocks were especially strong on the day as the SOX index vaulted 2.2%. As had been widely anticipated, The Federal Reserve announced Thursday that it was leaving interest rates unchanged. The funds rate therefore remains at 5.25%, where it has been for over a year now. While the Fed noted that inflationary pressures have persisted, it also dropped the term "elevated" to qualify the current level of inflation and acknowledged the fact that core inflation has come down in recent months. This was confirmed Friday with the release of the core-PCE deflator: the Fed's favored inflation gauge only rose by 0.1% in May, with the year-over-year reading now standing at 1.9%, a level the Fed should be comfortable with. Friday's session was a volatile one as is often the case on the last trading day of the quarter. Improved economic readings on manufacturing, construction spending and consumer sentiment initially boosted stocks, but the gains did not last as a bomb scare in London, higher oil prices and end-of-quarter window dressing by fund managers all combined to leave the major indexes with modest losses on the day.

For the week, the Nasdaq 100 gained 0.63%, while the S&P 500 and Russell 2000 were almost unchanged. All 3 indexes remain above both their 50-day exponential moving average (EMA) and 200-day EMA.

For its part, our World Index Ranking portfolio underperformed the US averages as it posted a 1.48% loss this week. The portfolio consists of the 5 top-ranked world indexes as of June 22, which marked the beginning of the current 4-week holding period.

Our current Buy signal remains in effect.

Trend Timing School

Time horizons

We all invest for one primary reason, and that is to grow our capital. In order to maximize the return on our investments, as most investors hope/strive/wish to "at least beat the market", we spend a lot of energy worrying about which investment strategies to use and with which specific investments. The how and the what of investing. Most of us want to ignore the other key ingredient of investing: time. The when and for how long of investing. Even the simplest of investments, a money market fund, requires time for the interest to accumulate. It does so reliably, day in day out, never a loss, always a fractional gain. Of course, as we suspect the low interest rate we earn there is not even keeping up with inflation, we cannot be satisfied with the returns of the money market fund. The stock market does historically deliver substantially higher returns, but it does so in erratic fashion and therefore at a substantially higher risk.

Besides the endless short term swings, pullbacks and corrections, the stock market goes through major bull and bear cycles, which come in two flavors: cyclical (from a few months to a few years) and secular (can last decades). See definitions in "Cyclical and secular bear markets". A cyclical bull market lasts on average 33 months and repeats every 5 years. But you cannot take the average frequency and duration to the bank because they vary so widely from one another. But coming back to the higher risk of the stock market and to the relevance of investing time horizons, a major bear market can set you back years. It took investors over 25 years to recover the losses suffered during the 1929 crash and ensuing bear market. Nasdaq buy and hold investors are still 48% below their early 2000 top. Sure, someone in their early twenties might have enough years to recover, but why waste 25 productive investment years simply to get back to even?

Bear markets are Trend Timing's reason of being. Does this mean that Trend Timing only works during bear markets? No, as we show below, the Model manages to eek out an advantage over buy and hold over the course of a bull market, provided enough deeper corrections, but we would be Trend Timers for life even without that, just for the bear markets. And we would do it only for the downside protection of a Long Only strategy which handsomely beats buy and hold in the long term, but we have the luxury of Long and Short to compound the gains.

The hard part with the time component is that markets frequently require extreme levels of patience, not so much during bear markets which tend to be quite lively and enjoyable for us Trend Timers, but during drawn out bull markets. As always, a chart helps visualize the bull market we are in.

Corrections in on-going bull market



At nearly 5 years of age this bull market is clearly getting long in the tooth. With that comes a lot of investor complacency. One of the well known constants of investing is that during bull markets the ranks of buy and hold proponents grows exponentially. Every day/week/month/year during which an alternative investment or strategy trails buy and hold is further proof of their superiority. In hindsight, vision is 20/20, and it looks as if it would have been so much better to simply buy at the bear bottom on October 9, 2002 and still be holding today. There are several fallacies in that theory, beginning with the fact that there are very few true buy and hold investors who stay fully invested all the way down to the bottom. Most have capitulated long before that. They are also the ones who jump back in way too late in the subsequent bull rise, when most of the profits have been made.

Looking at the chart, had the buy and hold investor held fully invested all the way through the bottom, the bull market would have returned him about 134% so far using the Nasdaq Composite Index , not bad. Looking at it closer we can see that the lion's share of the gains occurred before 2004. Since then, the return has only been about 30% in 3½ years. As many of us know from first hand experience, investors get very restless during slow periods interspersed with pullbacks and corrections. The low gains of late are also mostly a U.S. phenomenon because, as a point of comparison, the World Index Ranking with a simple Buy and Rebalance strategy would have returned over 130% since 2004. Yes, we understand that it would not have been possible because it was only launched during 2006.

Since 2004 U.S. markets have been very slow with low volatility. To wit, the Dow Jones Industrials and the S&P 500 have not seen as much as a 10% correction in years. Still, the Nasdaq Composite provided us with four corrections (defined as a drop of at least 10%) which our trend following model struggled to capture consistently. For example, using the last two corrections of 2005 and 2006 during which the index lost 11.52% and 14.78% respectively, the live Sell signals we issued on 3/7/2005 and 5/12/2006 gained only 2.29% and 3.72%. By definition trend following always loses a few percentage points after turning points, which explains why we do not even attempt to exploit pullbacks (defined as losses under 10%). On the bright side, the current Model with its various enhancements appears to have tightened the trigger as it would have returned 9.44% and 10.38% during the corresponding Sell signals.

Whenever we lose patience or get aggravated by small corrections or trailing buy and hold performance, we always try to remember that trend following has kept us safe from severe corrections and bear markets, notwithstanding the fact that none has occurred in the last long while. And we know it will allow our investments to leapfrog buy and hold when the inevitable strong corrections and bear markets do arrive.

FAQ of the Week

Question: Do ETFs have any disadvantages?

Everybody and their brother is singing the praise of ETFs as the ideal investment vehicles, us included. Convenience, low cost, and transparency are the first qualities which come to mind, but for anyone in need of a brief refresher on why ETFs are better than mutual funds and better than closed-end funds, simply follow the respective links.

Every so often an inquisitive subscriber asks if there are any disadvantages to ETFs. Besides being increasingly difficult to select without a systematic approach, as expanded on in last week's "ETFs top 500 billion in assets" article, we can find only a single drawback: transaction fees. Also known as broker commissions, they are the fees you pay your broker whenever you trade an ETF, as you would with stocks. Mutual fund proponents point to the no-load and no-transaction fees on many funds as a key advantage over ETFs, but we contend that these are easily overcome by the short-term redemption fees and higher expenses most of them charge.

With the infrequent trading of Trend Timing and the growing number of brokers offering ETF trading at sub-$10 levels, we feel commissions are a small enough price to pay for the benefits.

In the mean time we are keeping a close watch on ETF expense ratios which have been creeping up lately. While expenses for many of the conventional index ETFs are still extremely low, e.g. 0.08% for SPY and 0.2% for QQQQ, according to Morgan Stanley the average expense ratio for U.S. stock ETFs introduced over the last 3 months stands at 0.52%, a bargain against the 1.42% for average diversified U.S. stock mutual funds, but an increase of 21% versus the previous 3 months nevertheless. This rise is due in large part to increased specialization and use of leverage in many of the newer products.

Warm wishes and until next week.

The TimingCube Staff