Signal Type	Trade Date	Return since issued
		World	U.S.
			Nasdaq 100 (QQQQ) Russell 2000 (IWM) S&P 500 (SPY)

Market Update

Stocks experienced see-saw action this week to eventually finish with modest losses. The main indexes relinquished early gains Monday to finish little changed ahead of Alcoa's quarterly report, which marks the beginning of the fourth-quarter earnings season. The aluminum producer missed its profit target, setting the stage for a negative session Tuesday. Indeed, stocks gapped lower at the open only to drop further, as investors also had to face a warning from Chevron and news that President Obama wants to impose a "fee" on major banks. The Nasdaq Composite tumbled 1.3% on the day. The market managed to recoup all of the losses over the next two sessions despite disappointing economic news, as December retail sales and weekly jobless claims came in weaker than expected. After the close Thursday, Intel reported a ten-time increase in earnings vs a year ago, topping profit and revenue estimates, and issued bullish guidance for the current quarter. The news did little to help the market Friday, however, as investors instead focused on a disappointing consumer sentiment reading and news that losses from loans are still mounting at JPMorgan Chase. Market participants decided to take profits, sending all indexes lower on heavy trade, with the S&P 500 shedding 1.08% on the day.

The S&P 500 (SPY), Russell 2000 (IWM) and Nasdaq 100 (QQQQ) respectively lost 0.81%, 1.30% and 1.50% over the five-day span. All three ETFs remain located above both their 50-day and 200-day exponential moving averages (EMAs).

For its part, our World portfolio posted a 1.34% loss this week. The portfolio consists of the 5 top-ranked world ETFs as of January 1, which marked the beginning of the current 4-week holding period.

Our current Buy signal remains in effect.

Trend Timing School

Will Fed rate hikes derail the stock rally?

We wrote awhile back how bonds had been a stellar performer over the past decade. In fact, over the past 20 years, U.S. Treasury bonds have outperformed stocks, leading some to herald the wonders of bond investing and question why anyone would take the risks inherent in stock market investing. Chart 1 provides some context for the T-bond outperformance by showing rolling 20-year relative returns for stocks and bonds. It shows the difference between total returns in stocks and 10-year Treasuries. When the line drops below 0 on the chart, 10-year U.S. Treasury bonds will have outgained stocks over the most recent 20-year period. This recent outperformance is only the third such occurrence over the past century. Of more interest perhaps is what happened after that bond strength. The boxed notes display the subsequent five year return for stocks and bonds - the relative gain for stocks is substantial while bonds offer very little gain (even including interest payments). The other take-away from this chart is how short-lived was the bond outperformance. Almost the minute bonds became 20-year winners, the party was over for them.

Chart 1: S&P 500 versus 10-Year Treasuries


Looking at today's market, is the bond championship similarly on thin ice? The charts below remind us that U.S. Treasury yields have been declining for over 20 years fueling the good gains in bonds. For the bond championship to follow history and be a very brief event, we would look for Treasury yields to begin rising and/or stocks to rally. Stocks have (and continue) to do their part, digging out of the latest crash. However, thusfar, bond yields continue to operate in their long downtrend despite having risen from the depths of the 2008 crash. The 10-year and 30-year Treasury yield trends shown below demonstrate this. But the 30-year yield, in particular, appears on the cusp of a move OUT of the downtrend. Markets remain on pins and needles waiting for any sniff of a Fed rate hike and possible longer-term higher interest rates.

Chart 2: 10-Year Treasury Yield



Chart 3: 30-Year Treasury Yield



Does that Fed hike, when it inevitably comes, portend the end of the stock rally? We present the following history of stock market action just before and after prior Fed rate hike periods - called periods of rate "tightening". Chart 4 shows the range of monthly gains or losses for the Dow Jones Industrial Average. To the left of the middle gray line are months prior to the Fed's first rate hike. To the right are the months following the first hike. You can see that the market initially dips as the rate hike becomes imminent and through the first few months after the Fed action. But the damage to stocks is fairly limited - with an average loss of 4-5% prior to the first hike and only about a 2% hit after the event. Stocks then become comfortable with the new rate environment and return to concerns about economic and earnings growth. Those indicators would typically be reasonably strong if the Fed has felt compelled to raise rates and dampen growth. Thus, stocks resume their higher path.

Chart 4: Composite of 17 Discount Rate or Fed Funds Target Rate Tightenings


While interest rates do not really play a direct role in our Models, they do heavily influence stocks' price action. Fortunately, we do not have to guess when and how the Fed comes off the zero rate policy. It is certain that zero will not last forever. But history tells us that when the time comes and the Fed returns to nudging rates upwards, stocks will be fine, only pausing awhile before resuming their upward move.

FAQ of the Week

Question: What is the yield curve?

The yield curve is simply a picture of interest rates with varying maturities. Each type of credit securities will have a different yield curve. So, the curve for U.S. Treasury bonds shown below will have different rates than the curve for U.S. Corporate bonds. Most of the time, the bonds that mature further out in time will carry a higher yield than the short-term bonds. It's the same with CDs that you can get from a bank - the further out in time, the higher the rate you receive. The bank's reason for that higher rate over time is the incentive to capture your money for a longer time. In the credit markets, the higher rate reflects increased uncertainty and risk. We just don't know what the future holds. So, a bond maturing thirty years from now carries more uncertainty about things like inflation and the economy than a bond that matures sooner. You also expect that increasing economic growth will lead to higher interest rates. Thus, the default yield curve rises throughout time because of growth as well. In rare cases, the yield curve can become "inverted" meaning that near-term rates are actually higher than longer-term rates. This inversion in yield behavior often presages a recession. It is the market's way of saying that rates will be coming DOWN rather than going up in the future. It will be weak economic conditions that will usually

push rates down as the Fed lowers rates to stimulate the economy. (Note that the Fed only sets the very short-term rates. All other rates are set by the market.) The most recent inverted yield curve arrived late in 2006 through early 2007. Though it took awhile, the economy did indeed roll over and rates fell significantly as the yield curve had predicted. As the chart on the right also shows, longer term rates have moved higher as the economic recovery has gained traction over the past year (though the charts in the above weekly point out that rates are still downtrending or flat when viewed over a longer timeframe). The yield curve is a very handy tool for quickly assessing the market's view on interest rates, inflation, and economic growth.

Treasury Yield Curve

Warm wishes and until next week.

The TimingCube Staff