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

Market Update

Markets experienced an up and down week that left stocks little changed overall. The main indexes posted modest gains in the first two sessions of the week amid news of large job cuts at major companies such as Caterpillar and Home Depot, and an encouraging economic report that showed a 6.5% increase in existing-home sales in December. Investors were also encouraged by better-than-expected earnings reports from McDonald's and U.S. Steel. Fueled by renewed hopes that more help is on the way for the troubled financial sector, stocks surged Wednesday, also helped by the Fed's decision to leave interest rates unchanged. The central bank pledged to boost the economy using less conventional means, such as buying mortgage-backed securities and long-term Treasury bonds. By day's end, the S&P 500 had gained 3.4%. Stocks reversed course Thursday and relinquished all of the previous session's gains. Investors decided to sell after the latest economic data showed that new home sales hit their lowest level on record in December while orders for durable goods dropped for the fifth month in a row. Sellers remained in control Friday as stocks fell again despite the release of a better-than-feared GDP report. The Commerce Department said that the economy contracted at an annualized rate of 3.8% during the last quarter of 2008. While the reading turned out to be better than the 5.8% drop economists expected, it still marks the steepest decline in economic activity since 1982. Reports that the government's initiative to provide more help to banks will likely be delayed also weighed on investors' minds. The net result was a 2.3% daily drop for the S&P 500.

The Nasdaq 100 (QQQQ) and Russell 2000 (IWM) respectively gained 0.55% and 0.20% on the week while the S&P 500 (SPY) lost 0.34%. 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 0.53% 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. The World portfolio is being rebalanced today, as the current 4-week holding period is now over. 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

The fear factor

It is often said that the stock market reflects all the information available and the collective beliefs of all investors about future prospects. It is therefore no surprise that many have been trying to measure the key human sentiments that alternate and balance to drive our investing tendencies: greed and fear. Judging by the just released January reading of the widely watched Conference Board Consumer Confidence Index, which sets a new historic low at 37.7 (the reference being 1985 = 100), and their Expectations Index which is still decreasing as well, it is clearly fear which currently reigns, and it is still worsening. Many economists and market pundits view this as a sure sign that the bottom of the cycle has not yet been reached.

Consumers have been losing a big chunk of their net worth through a combination of loss in value of their home and of their investment portfolio, not to mention their savings for those who have seen pay cuts, mandatory holidays or complete job loss. There is little doubt that the record numbers of mass layoffs is sapping at consumer's sense of confidence.

When it comes to investor sentiment indicators, much like our own emotional urges, they tend to be contrarian indicators. Bull markets always begin when investor sentiment is at its worst and end when there is too much optimism and complacency.

Unlike many sentiment indicators which are based on surveys and are published once a month, other indicators are sought for their real time nature. This is one of the reasons many economists watch and rely on the Treasury-Eurodollar spread, or TED spread, they claim to be a historically reliable leading indicator of the economy and stock market. Chart 1 below provides a one year view of the TED spread (in blue) and the S&P 500 (in red) as a stock market reference. Investopedia explains it best: "The TED spread can be used as an indicator of credit risk. This is because U.S. T-bills are considered risk free while the rate associated with the Eurodollar futures is thought to reflect the credit ratings of corporate borrowers. As the TED spread increases, default risk is considered to be increasing, and investors will have a preference for safe investments. As the spread decreases, the default risk is considered to be decreasing."

Chart 1: The TED spread as credit risk indicator



The TED spread which in October 2008 had zoomed to over 4.6% in the wake of the Lehman collapse, recently dropped back to the 1% level. This is still above historical norms but it is the lowest reading since August 2008 and it is indicative of calmer traders and thawing credit markets. Many economists and other tea leaves gazers take this as a good omen for the economy and the stock market. But not all sentiment indicators agree.

Mark Hulbert, a master of contrarian analysis, has become famous for his market predictions based on his Hulbert Stock Newsletter Sentiment Index (HSNSI) which reflects the average recommended stock market exposure among a subset of short-term stock market timing newsletters tracked by the Hulbert Financial Digest. Just recently he wrote "Going into Thursday's session, the HSNSI was some 36 percentage points higher than where it stood at the November lows. In other words, unlike the March 2003 retest, when there was a lot more pessimism than at the first low, this time around there is a lot less pessimism. On my interpretation of contrarian analysis, therefore, odds are that the bear market has more work to complete on the downside before the bottoming process is likely to be over."

Admittedly, market timing newsletter publishers are a special breed (it takes one to know one) and maybe a sentiment indicator tracking actual investors would be more accurate. To this end the Volatility Index (VIX) which tracks the implied volatilities of a wide range of S&P 500 index options has become a widely used measure of market risk and uncertainty and ultimately of investor fear. Chart 2 below depicts the VIX (in blue) and its relationship with the S&P 500 (in red).

Chart 2: Market volatility as fear and uncertainty indicator



There is an entire sub-discipline of technical analysis dedicated to the VIX. In short, absolute values of the VIX have little meaning, but most agree that peaks in the volatility index have nicely coincided with intermediate market bottoms. The trouble is that the VIX does not indicate if there is a higher volatility peak (and lower market low) coming up ahead or not. And this is the fatal flaw of all sentiment indicators and why they play no part in our timing model.

While we are on the topic of dubious stock market timing indicators, it is very timely to mention the much hyped Super Bowl Indicator which, if you believe the legend, positively guarantees 2009 to be a winning year for the stock market. Fans of the indicator argue that a Super Bowl win by a team of the original NFL league foretells an up year for Wall Street, but if an old AFL (now AFC) team wins, brace for stock market declines that year. They point to a track record of 33 correct calls for 42 Super Bowls (79% accuracy) as proof sufficient. The catch this time is that the AFC champions Pittsburgh Steelers were originally in the old NFL league which means that regardless of the ultimate winner of Sunday's Super Bowl XLIII, the stock market has no choice but to go up! But don't bet the house on it, please... because last year another original NFL team won, the New York Giants, and we all know what a terrific year 2008 turned out to be for the stock market!

FAQ of the Week

Question: What indicators do you follow?

Even though we do not seek to predict what the market will do next, as investment professionals we follow dozens of indicators to further our awareness and understanding of what the market is actually doing, and to shore up our commentaries. When it comes to our mechanical timing model, simplicity is the key and we shun traditional indicators to concentrate on a few rules of our own.

As discussed in this week's Trend Timing School article above, we do not follow investor sentiment indicators in our model. We obviously cannot disclose all the model's inner workings or we would no longer have a viable service, but what we can say is that the data we primarily focus on is the price and volume of the Nasdaq Composite index. From these daily data points and their history the model analyzes the interaction of price and volume movements over time in order to detect changes in the intermediate (3-5 months) market trend. A big clue of market turning points is contributed by what institutional investors do, because the collective amount of money they commit is what actually makes market trends. For example, sustained and repeated price increases (decreases) with high and increasing volume, sometimes called accumulations (distributions), are sure signs that the giants are moving in (out) of the market. To keep us out of trouble, internal readings within our model also detect oversold or overbought market conditions and provide further downside protection with a stop loss at 9% from entry followed by a 15% trailing stop.

Warm wishes and until next week.

The TimingCube Staff