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

Market Update

Stocks lost more ground during this holiday-shortened week. Tuesday may have been a historic day with the inauguration of President Barack Obama but it was also a day to forget for investors as stocks moved markedly lower on the back of steep losses in the financial sector. Citigroup shares fell 20% on the day while Royal Bank of Scotland lost 69% of its market capitalization after it warned that it may report a loss in excess of $40 billion. The main indexes fell all day, with the Nasdaq Composite diving 5.8%. After the close, IBM reported solid quarterly earnings results and issued a positive outlook for the year. The news helped turn the mood around Wednesday, as stocks experienced a sharp rebound that almost erased Tuesday's big decline. Tech stocks led the market lower Thursday, after Microsoft missed its quarterly earnings and revenue targets and announced that it will shed 5,000 jobs. The software giant's stock lost 12% during the session and contributed to a 2.8 drop for the Nasdaq Composite. It was then Google's turn to report its quarterly results and the company did not disappoint as it beat expectations. The news helped the tech sector move higher Friday while a rebound in energy and financial stocks resulted in a 0.54% daily gain for the S&P 500.

The Nasdaq 100 (QQQQ), S&P 500 (SPY) and Russell 2000 (IWM) respectively lost 1.77%, 2.29% and 4.50% on the week. All 3 ETFs remain located below both their 50-day and 200-day exponential moving averages (EMAs).

For its part, our World portfolio posted a 3.68% loss this week. The portfolio consists of the 5 top-ranked world ETFs as of January 2, which marked the beginning of the current 4-week holding period. Please note that since we now have an active Cash signal, the World approach calls for selling your holdings if you follow the "Long Only" or "Long and Short" strategy. Only if you follow the "Buy and Rebalance" strategy should you remain invested in the top 5 ETFs, as the strategy calls for staying invested at all times. Please go to the "Our Service" page for all the details.

Our current Cash signal remains in effect.

Trend Timing School

What to expect from Inverse and Leveraged ETFs?

With the current bear market now well established, most of us are probably eager to take advantage of the latest leveraged or inverse index ETFs in the event a new signal is triggered by our model. More and more of these new products have become available lately giving us, trend followers, a vast selection of tools to choose from. It starts with the simple inverse index ETFs to the ones offering 2x or even 3x multiple like with the recent additions to the Direxion family of ETFs. But before going too far ahead of ourselves, we should pause for a moment and reflect on the true characteristics of these new investment vehicules.

Some of our astute subscribers have already noticed that these leveraged and inverse ETFs do not always perform as expected. In theory, these instruments seek daily investment results, before fees and expenses, that correspond to the inverse (opposite) and/or multiple of the daily performance of the index they are tracking. So, for instance the ProShares Ultra Short QQQ should double the inverse of the performance of the Nasdaq 100, similar to shorting the QQQQ on full margin. Well, theory does not always work as expected. There are minor differences attributable to small tracking errors, spread and fund expenses, neither of which explain some of the discrepancies. While disturbing, this behavior is perfectly normal once you understand how the ETFs operate and how compounding works.

These ETFs are designed to produce the intended performance on a daily basis. If you analyze their daily track record you will see that they do an amazingly good job day by day. So why doesn't this translate into consistent tracking over longer periods of time? Blame it on compounding. For the mathematicians out there, they are not just Delta products, they also have a Gamma component.

For those of us without a PhD in Math, let's look at a couple of specific examples to illustrate the phenomenon. The first example shows five mostly trendless days during which the index just bounces up and down, compared to an ETF that attempts to double the opposite of the index performance. During the week the index returned a -5.47% loss so it would be logical to expect the fund to return -5.47% x -2 = +10.94%. Although the ETF perfectly achieved its -2x objective every day, for the week it returned only +7.81%, which is almost 30% less than expected in just one week. The reason is that losses always count for more than gains (if you lose 50% of $1 you have to gain 100% to get back to $1) and this negative bias is amplified by compounding. So the longer a trendless market lasts, and the higher the volatility, the worse off you are in a leveraged ETF.

Example 1 - Trendless market

	Index	Start $	End $	Fund	Start $	End $
Day 1	-5%	$10,000	$9,500	+10%	$10,000	$11,000
Day 2	+5%	$9,500	$9,975	-10%	$11,000	$9,900
Day 3	-5%	$9,975	$9,476	+10%	$9,900	$10,890
Day 4	+5%	$9,476	$9,950	-10%	$10,890	$9,801
Day 5	-5%	$9,950	$9,453	+10%	$9,801	$10,781
Result			-5.47%			+7.81%

On the bright side when the market mostly follows a clear trend, up or down, the leveraged ETFs can do substantially better than expected. In our second example below we compare the performance of the same ETF to an index that keeps falling. After five down days the index has lost -22.62% and you would be thrilled if your leveraged bear ETF returned the expected -22.62% x -2 = +45.24%. Yet the ETF manages to exceed your lofty expectations by returning a staggering +61.05%.

Example 2 - Trending market

	Index	Start $	End $	Fund	Start $	End $
Day 1	-5%	$10,000	$9,500	+10%	$10,000	$11,000
Day 2	-5%	$9,500	$9,025	+10%	$11,000	$12,100
Day 3	-5%	$9,025	$8,574	+10%	$12,100	$13,310
Day 4	-5%	$8,574	$8,145	+10%	$13,310	$14,641
Day 5	-5%	$8,145	$7,738	+10%	$14,641	$16,105
Result			-22.62%			+61.05%

While these are theoretical examples, there are numerous instances in our recent history that demonstrate this occurrence perfectly. For instance looking at the Sell signal we had last year from 1/7/2008 to 4/2/2008, the QQQQ lost -5.5% while the 1x inverse ProShares Short QQQ gained +4.7%, and its double inverse counterpart (ticker: QID) gained +8.1%, less than the +11% one could have expected.
The implication of all this is that these index ETFs are not always perfect investment vehicles, but understanding how they work allows us to make informed decisions. Trend Timing always does better in a trending market and these investments are no different.

FAQ of the Week

Question: What is the "Alternate E-mail address" for?

In case you did not notice it, the "My Profile" page on the Web site provides for both a "Primary E-mail" and an "Alternate E-mail" address. While only the "Primary E-mail" is mandatory when you subscribe, we highly recommend you use both. The two addresses were intended to give you more flexible and reliable access to the signals. Many of us have both a home and a work e-mail address which we could use, not just for convenience but to increase the chances of receiving a signal when it comes.

Alas, in this day of raging spam, many e-mails do not reach their destinations due to various overzealous countermeasures along the way. For details on how to increase your chances of receiving our e-mails, and to find out how to perform an end-to-end delivery test, read Why am I not receiving your emails?. Sometimes, despite all the precautions, e-mails will be filtered by your e-mail service provider and you may have no control over it. The best way to protect against such occurrences is to set-up an "Alternate E-mail" address with another provider. It is highly unlikely that two service providers start blocking the same type of e-mail at the same time, the redundancy greatly increases the likelihood of proper signal reception on your end.

Warm wishes and until next week.

The TimingCube Staff