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

Market Update

Stocks continued to lose ground this week. Markets started by falling sharply Monday on renewed fears surrounding the financial sector after insurance giant AIG reported that it is seeking additional funds from the government. Worries over the auto industry also resurfaced after a report said that the Obama administration is weighing the consequences of a possible bankruptcy filing by General Motors and Chrysler. The medical sector also took a beating after the government announced plans to limit Medicare-related expenditures. The sum of bad news caused the S&P 500 to drop 3.5% on the day. Buyers returned to the market Tuesday as a sharp rebound on heavy volume caused the major averages to recoup all of Monday's losses. The rally was largely attributed to comments from Fed Chairman Bernanke, who told congress that the current recession could be over by year's end. The gains did not last, however. If stocks only faced modest losses Wednesday, selling intensified during the next session as the medical sector was once again hit hard, causing the major averages to close just above Monday's lows. Friday's trading was marked by choppy action. News broke that the government is taking a 36% stake in Citigroup and that General Electric is slashing its dividend. On the economic front, the Commerce Department reported that GDP contracted by 6.2% during the last three months of 2008, marking the worst showing since 1982. By day's end, the S&P 500 had lost another 2.4% to close at levels not seen since 1997.

The S&P 500 (SPY) , Nasdaq 100 (QQQQ) and Russell 2000 (IWM) respectively lost 4.51%, 4.64% and 4.84% 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 4.01% loss this week. The portfolio consists of the 5 top-ranked world ETFs as of January 30, 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

Dow Jones indexes as market indicators

The Dow Jones indexes and the Dow Theory which deals with the interaction of the Industrial Average and the Rail Average (oops, it is now called the Transport Average ) was the first stock market timing approach developed over 100 years ago and has been followed ever since. Some swear by it, others laugh at it. Why should we bring up the Dow Theory at this time you ask? The obvious reason is that just this past week the conditions were met for a Dow Theory sell signal, again. Maybe even more important for the anecdote is that it is also a rare occasion when three of the leading Dow Theory gurus agree. They are Jack Schannep, editor of TheDowTheory.com, Richard Moroney, editor of Dow Theory Forecasts and Richard Russell, editor of Dow Theory Letters. Well, they almost agree. One of them is still one third bullish, another sees this merely as a re-confirmation of a previous signal and it took the third until last week to finally declare a bear market.

But we are getting ahead of ourselves and a little refresher would be handy right now. Let's first review what the Dow Theory is all about and where it came from. Charles Dow created and began studying the Dow Jones Industrial and Dow Jones Rail indexes in the late 1800s, and wrote about the stock market in his now famous editorials for the Wall Street Journal from 1900 to 1902. For the first time the stock market was described in technical terms, with structure and organization instead of the mere entertainment and gambling it was regarded as in those days. Dow claimed that the method for making money in stocks was to study basic conditions and exercise enough patience to capture the major movements. A Trend Timer if we ever saw one!

After Dow's death in 1903, his understudy William P. Hamilton picked-up where Dow left off and continued the legacy by writing, as editor in chief of the Wall Street Journal, about the Dow Theory for over 20 years. His writings serve as basis for much of today's technical analysis and trend following. His approach for identifying trends with "higher highs" or "lower lows" was revolutionary and still used today, although he stated himself that the Theory was not infallible. He proved it very publicly when he mistakenly declared a primary bear market in early 1926, over 3 years too early, instead of the secondary reaction in a primary bull market it turned out to be (i.e. a correction). Still, he will be forever known for his October 25, 1929 editorial "A Turn in the Tide" which revealed a Dow Theory bear market signal just days before the crash.

Although Dow and Hamilton never mentioned trends directly, the vast majority of their observations are about fundamental trend following analysis. Since then there has been a long line of Dow Theorists which have separately expanded on the initial guidelines to create some very elaborate trading systems in which interpretation and point of view play large roles. We will not attempt to go into the details of the Theory here but the inventors stressed that for a primary trend buy or sell signal to be valid, both the Industrial Average and the Transport Average must confirm each other. If one average records a new high or new low, then the other must soon follow for a Dow Theory signal to be considered valid.

To bring this back to the situation at hand, let's look at the Chart 1 below which depicts the two Dow Averages (Industrial in red; Transport in blue) over the last 15 months or so.

Chart 1: Dow Theory in action



What all the brouhaha is about relates to the two horizontal lines being broken. In order to issue a Dow Theory sell signal the following must happen:

Critics of the Dow Theory say that the Dow indexes are now lagging the economy and that by waiting for new highs/lows to trigger signals, the method is essentially a "buy high" and "sell low" proposition. Dow and Hamilton never intended their guidelines to be used as the sole predictor of markets but rather as broad confirmation indicators. Clearly, it cannot be said that the indexes are made of blue-chip companies anymore (see "Is the Dow Jones Industrial Average index obsolete?" below) or that they represent the leading edge of the industry as they did once.

As usual, our system stays clear of any approach depending primarily on interpretations and predictions.

FAQ of the Week

Question: Is the Dow Jones Industrial Average index obsolete?

Critics have long argued that the 30 large cap stocks in the 112 year old index have grown stale and do not reflect a meaningful cross-section of the American economy anymore. Over the years industry sectors represented have changed drastically as can be seen in Table 1 below. The data compares the sector weights in the Wilshire 5000, which includes all companies traded on the major U.S. stock exchanges and is generally regarded as the most accurate view of the market as a whole, and in the Dow Jones Industrial Average index. While some sectors are about right, the Dow is clearly underweight in Financials and overweight in Industrials and Consumer staples.

Table 1: Industry sector distribution of market indexes

	Wilshire 5000	Dow Jones Industrials
Information technology	15.38%	15.57%
Financials	14.77%	4.80%
Healthcare	14.41%	10.03%
Energy	12.10%	14.42%
Industrials	11.36%	18.56%
Consumer staples	11.12%	17.46%
Other	20.86%	19.16%

The composition of the index is tightly controlled by a team of editors at The Wall Street Journal and the changes are few and far between. The last change occurred in September 2008 when insurer American International Group (AIG) was removed, after the U.S. government took a large ownership stake, and replaced by food giant Kraft Foods (KFT). There used to be a rule about shares of companies in the index having to be worth at least $10. Any company wilting under that key threshold used to be dumped in ignominy. No longer. A closer look at the index reveals that there are now five companies trading in the single digits:

• Alcoa (AA)
• Bank of America (BAC)
• Citigroup (C)
• General Electric (GE)
• General Motors (GM)

Citigroup is the worst of the bunch and, as we write this, it is down another 28% just this morning as it trades at $1.77. Instead of waiting for the index to be adjusted to the realities of the 21^st century, most investors have moved on to use more relevant indexes. For our part we have long adopted the Nasdaq Composite index as our preferred proxy for the broad U.S. market.

Warm wishes and until next week.

The TimingCube Staff