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

Market Update

It has been a punishing week for the markets. After a sizable rally on Tuesday, stocks reversed course the next day as shares were hit by renewed credit crunch fears and news that China may reduce its exposure to the dollar by favoring stronger currencies such as the euro for the country's reserves. The market weakness spread to tech stocks Thursday after Cisco Systems' quarterly report and outlook proved disappointing to investors. Other tech leaders such as Apple and Google also fell hard in sympathy. Stocks posted more losses Friday, as the technology sector was hit once again after Qualcomm's earnings guidance came in below consensus estimates. Wachovia's announcement that its write-down of bad loans would be larger than first announced also did not help and stocks ended the week on a sour note.

The S&P 500 and Russell 2000 respectively lost 3.71% and 3.18% on the week. The Nasdaq 100, which had been the leading index since the rally started in August, experienced a much steeper loss of 8.11%. It has now crossed below its 50-day exponential moving average (EMA), but remains above its 200-day EMA. The S&P 500 and Russell 2000 are situated below both their 50-day and 200-day EMAs.

For its part, our World Index Ranking portfolio did much better than its US counterparts this week, as it only lost 2.89%. The portfolio consists of the 5 top-ranked world indexes as of October 12, 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.

Despite this week's steep losses, our current Buy signal remains in effect

Trend Timing School

Sovereign wealth funds

In last week's Trend Timing School article we described the unprecedented money supply growth in emerging economies and the explosion in global liquidity these loose monetary policies are causing. Further amplifying liquidity, huge trade surpluses have bloated the foreign exchange reserves of exporting and oil producing countries.

Foreign exchange reserves are assets of the central bank of a country, held in something other than the local currency, which are used to back its liabilities (such as the currency it issued). The reserves are commonly held in currencies like the dollar, euro and yen, gold and IMF (International Monetary Fund) reserve positions. The table below lists the countries with the largest reserves as of July 2007, and their respective year over year growth. Most notable for their recent growth are China and Russia in positions 1 and 3. In fact, China just released their September numbers which have jumped another 8% to $1.43 trillion in just 2 months!

Don't look for the U.S. on this list of cash rich nations; not while it is running a yearly deficit approaching $1 trillion.

Central bank foreign reserves as of July 2007

	In trilions	Year over year change
China	$1.33	39.4%
Japan	$0.91	6.0%
Russia	$0.41	58.0%
Taiwan	$0.27	2.3%
Korea	$0.25	11.1%
India	$0.22	39.4%
Euro Zone	$0.21	13.5%
Brazil	$0.16	133.9%
Singapore	$0.14	11.3%
Hong Kong	$0.14	7.0%

An estimated 65% of these reserves are in U.S. dollars. A number of countries including China, Russia, Singapore and South Korea, have clearly announced their intentions of reducing the dollar exposure of their foreign reserves. Just this week, comments made by Cheng Siwei, the vice chairman of China's national parliament, signaled China might adjust its foreign currency reserves. Diversification out of the dollar can be accomplished by central banks by two methods. One is deceleration, if not ceasing, of the purchase of U.S. Treasury instruments, and the second is the use of a growing globalization phenomenon: the state owned and run investment funds, also known as stabilization funds or sovereign wealth funds.

Central banks have traditionally kept their reserves in liquid assets such as U.S. Treasuries (it used to be gold). From being generally viewed as low-risk, such dollar-denominated securities are increasingly perceived as liabilities. Instead of a nearly certain erosion in value these governments are seeking diversification and higher returns by investing in real estate, commodities, corporate bonds, stocks, or, on occasion, entire companies. To do so, assets are siphoned out of foreign exchange reserves and earmarked for investment in sovereign wealth funds.

Interestingly, the foreign exchange reserves figures in the table above do not include these sovereign funds. Some countries like Kuwait have operated investment funds for decades but what is new is the fact that strategic rivals like China and Russia are now pumping massive amounts of cash into them. The largest investment funds are the United Arab Emirates' ADIA (Abu Dhabi Investment Authority) with $1.3 trillion, Singapore's GIC (Government of Singapore Investment Corporation) with $330 billion, and Norway's GPF (Government Pension Fund of Norway) with $315 billion. China's recently created fund (China Investment Company Ltd) already ranks number 6 at $200 billion. The IMF is projecting that assets in these funds will grow from about $3 trillion now to $10 trillion by 2012.

Supporters laud the sovereign funds as "good globalization" because they provide long-term productive capital for cross-border investments which can help offset the flow of capital out of rich economies. However, as the size and influence of these state directed funds grows they are fast becoming the new masters of global finance. Not surprisingly, some fear that instead of seeking higher returns the funds will be invested for strategic and geopolitical reasons. At times, such foreign investments can become national security threats which naturally invoke protectionist reactions. Specific examples were the 2005 attempt by China's state-owned oil company CNOOC Ltd. to acquire U.S. oil and gas producer Unocal Corp., dropped after the outcry over national security, and last year when DP World of Dubai was pressured to sell the U.S. port operations it had acquired as part of a larger deal.

There is a growing argument in Western countries that if state-run companies or funds are to invest in key strategic industries that they (China and Russia in particular) must open to foreign investments as well. Instead, the investment funds have become smarter and now try to avoid political strains by only buying minority stakes in companies rather than outright takeovers. The first deal of China's Investment Company was the $3 billion it paid for nearly 10% of the Blackstone Group, an American investment firm. Another U.S. private equity group, Carlyle, sold 7.5% of itself to Abu Dhabi in September and now is in talks to sell another 9.9% to the Chinese. Yet to receive regulatory approval is a proposed deal by Dubai to acquire 19.9% of the Nasdaq stock exchange.

In the end, all the liquidity sloshing around the world in search of returns works to perpetuate the current worldwide bull market in various asset classes, and equity markets in particular. Since many of these funds are in U.S. dollars, the target of much of this investment will remain assets in the U.S. While sovereign funds cannot prevent temporary weakness, to wit the pullback we are currently experiencing, many economists anticipate that the continued capital flow they represent will keep the bullish trends going for the foreseeable future.

FAQ of the Week

Question: Does the Model incorporate safeguards against excessive losses?

Yes, we incorporated a way to limit losses in our Model: a Cash signal is automatically issued if the Nasdaq Composite Index moves against our current position by more than 9%, on a close, from our Buy or Sell entry point. This is designed to keep any losses to a reasonable minimum from the entry point when we are most vulnerable.

Once the Nasdaq Composite Index has advanced 7% or more from our entry point, the maximum drawdown limit is ratcheted-up to 15% and the Cash signal becomes a trailing stop. This means that from then on, if the Composite declines 15% from its most recent closing high on an active Buy signal, or moves up 15% or more from its recent closing low on an active Sell signal, a Cash signal will be issued.

While the safeguards exist, the 9% and 15% Cash signal varieties have never been triggered. The few Cash signals in our history were associated with conflicting trend conditions.

Warm wishes and until next week.

The TimingCube Staff