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

Market Update

Stocks experienced a week of see-saw action that eventually left the major averages with modest losses. After equities failed to build on last week's momentum by relinquishing early gains Monday, the main indexes retreated in earnest during the next session, yielding the Nasdaq Composite a 1.3% loss on increased trade. The tumble was caused by a poor Consumer Confidence index, which hit only 46 for the month of February when economists expected a reading of 55. Stocks rebounded Wednesday to recoup most of their losses after Fed chairman Ben Bernanke told Congress that the Central Bank would keep the lid on interest rates for "an extended period". The day's action occurred on light volume, however, indicating a lack of participation among institutional investors. An unexpected increase in weekly jobless claims resulted in an initial drop for stocks Thursday. A late retreat by the dollar helped the main indexes right themselves to finish the session well off their 2% intra-day lows. The government released revised fourth quarter GDP numbers Friday morning. The growth rate was upwardly revised to a better-than-expected 5.9%, but the news was counterbalanced by a 7.2% drop in existing home sales for January. Stocks remained directionless all day to finish little changed.

The Nasdaq 100 (QQQQ), S&P 500 (SPY) and Russell 2000 (IWM) respectively lost 0.16%, 0.36% and 0.41% over the five-day span. All three ETFs are located above both their 50-day and 200-day exponential moving averages (EMAs).

For its part, our World portfolio underperformed its U.S. counterparts this week with a loss of 1.47%. The portfolio consists of the 5 top-ranked world ETFs as of January 29, 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

An update on the markets and economy.

With our Cash signal indicating a period of market indecision and uncertainty, we have a chance to step back and assess the state of the markets and possible drivers for future moves.

Most importantly, markets have normalized from their near-death experience in late 2008. Interest rates and interest rate spreads have returned to their pre-crash levels in accordance with a credit market that has healed substantially from its crisis. The surge in Treasury yields that some feared a year ago (and continue to fear) simply has not happened. Longer-term Treasury yields have gone higher over the past year, but are only back where they were before the dislocations of the credit market seizure, with a 30-year Treasury bond yielding around 4.5%. Similarly, high-grade corporate bonds are back to their 2007 levels of 5.0-5.5% yields, with lower quality corporates also back to 2007 levels. The spread between these rates, an indicator of perceived risk, has also dropped back to normal levels. While the global credit markets worry about how the Eurozone will resolve Greece's deficit funding problems, these concerns have not spread very far. Emerging market bonds, for example, have been completely unfazed by the issues with Greece and other possible problem countries, such as Portugal and Ireland. Recognize that these are rather small debt situations relative to the issues global banks faced a year ago. Of course, most of those same banks - be they private or public/sovereign - are still recovering and not yet healthy enough to take on another major struggle; thus the worry.

Economically, the world appears to be recovering slowly from the worst recession in decades. Almost all indicators have at least bottomed, with many having experienced several months of positive trend. The housing market should continue to struggle, but prices have slowed their downward fall and are even ticking slightly higher in some major cities. Piles of underutilized factory and labor capacity should allow the economy to resume output with little upward pressure on prices. This gives the Fed room to keep interest rates low removing one risk to a happy stock market. Indeed, China's recovery has been so quick (never actually having dipped into a recession), that their government is taking significant steps to slow growth.

Corporations have been able to leverage cost reductions into improving profits. A resumption of sales growth should largely fall straight to the bottom line with healthy profit margins, given the slack in factories and labor markets. Chart 1 below shows how corporate earnings have come back from their 2008 nightmare to be back on track with the S&P 500 delivering over $50/share in earnings for 2009.

Chart 1: S&P 500 Earnings, Inflation Adjusted


Source: www.multpl.com

With stock prices being the combination of earnings and what investors are willing to pay for those earnings - e.g. the P/E ratio, we need to examine the P/E ratio as well. Chart 2 shows that stocks, while not really cheap, are not outrageously expensive either. They are valued at a fairly normal level for a low inflation/interest rate period.

Chart 2: S&P 500 P/E Ratio


Source: www.multpl.com

That leaves us to the prospects for future earnings growth and P/E expansion as fodder for future stock price growth. Standard & Poor's estimates that earnings will grow about 13-14% this year. Assuming the P/E remains as is, the S&P 500 would grow by a similar 13-14%. A bout of cautiousness by investors dropping the P/E ratio by just one point would reduce the projected gain by 5%, or to 8-9%.

Of course no one knows what will really happen with corporate earnings, or certainly not with investor mood, going forward. With short-term interest rates certain to rise from near zero, and some spillover of that increase to longer-term rates, it's certainly reasonable to conclude that bonds might not offer the stellar returns of the past decade. If the economy can remain stable and begin showing consistent growth, one would expect stocks to perform reasonably well if only because money would partially leave bonds in favor of stocks.

However, there are plenty of flies in the ointment. We have written in the past how U.S. labor markets have, over this age of globalization, become much less able to quickly recover from recessions. This time will be no different with high levels of unemployment dragging on for many months, regardless of what actions the federal government takes. China's growth will certainly moderate from the frenzy of Olympic games-induced growth of 2003-2007. However, China's economic base (and that of India, Brazil, Russia) is quite a bit larger than earlier in the decade; thus, the net economic benefit of the growth can actually be greater. That returns us to Europe, which is the crisis du jour, and one for which the market is desperate to see some signs of support and resolution.

Of course that brings us to why we favor a trend timing approach to investing. Reading the various crosscurrents and trying to guess the market's future direction is a difficult game and one that few investors reap rewards from (just look at mutual fund returns over the past decade for proof). Our hats off to those savvy folks who can consistently win with their economic analysis. However, our tried and true (and very simple!) methodology delivers investment gains without the angst of wondering whether we have properly analyzed the Greek debt crisis, or accurately modeled China's economic growth, and when the U.S. employment picture will improve. We are just reacting to what the market is telling us. Right now, it is saying that there is quite a bit of uncertainty and the trend of the market is unclear. As always, that will change and our signal will light the new path. Until then, sit back and enjoy the rather riskless comfort of holding cash.

FAQ of the Week

Question: Should I consider some of the new "actively managed" ETFs?

Over the past few months, a few ETF providers have announced and offered ETFs that do not passively follow a specific bond or equity index. Instead, they provide active management within the ETF in an attempt to provide better returns and risk management than a purely passive index approach. Thusfar, the bulk of these actively managed ETFs have focused on bonds. Individual investors tend to be less active and confident in managing their own bond portfolios, instead deferring that duty to bond mutual fund managers. Individuals seem much more comfortable building and trading a stock portfolio, even though stocks deliver far more risk in most times. Bonds were late to the ETF party, but have become very widely used in the past couple of years. As bond ETFs have become more and more popular, it makes sense that bond mutual fund houses and other bond managers would see an opportunity to use ETFs as the vehicle to gather assets for their management.

Of course, there are already very many mutual funds providing active management. And being actively managed has not prevented them from suffering the harsh declines that the markets can deliver. It is very early in the life of the actively managed ETFs. Thus, it will be a good while before we know how much value they are adding compared to the passive index ETFs. We certainly see no reason why their returns will be different than similar actively managed mutual funds. As longtime champions of the benefits of ETFs, we applaud and appreciate the continued growth of the offerings available to investors. As always, it's important to understand what you are really buying, what the fees and costs are, and how it fits within your portfolio and investment objectives.

Warm wishes and until next week.

The TimingCube Staff