Signal Type	Trade Date	Index	Return since issued
		Nasdaq 100
		Russell 2000
		S&P 500

Cumulative Returns since First TimingCube Live Signal () as of

Index	Long Only	Long Only with Margin	Long & Short	Long & Short with Margin	Buy & Hold
Nasdaq 100
Russell 2000
S&P 500

Market Update

So far, 70% of S&P 500 companies that have reported first-quarter earnings have surpassed analyst estimates. This number is to be compared to the 57% average since 1992. Earnings season is therefore off to a good start. As always, there are high-profile exceptions, such as Microsoft, which released disappointing numbers and forward guidance Friday. The stock sold off as a result, as almost 600 million shares changed hands that day alone. The day before, markets first got spooked by news that China's central bank increased interest rates for the first time since 2004, raising worries that global economic growth may slow down. The indices quickly erased their losses after Ben Bernanke's testimony to congress indicated that the Fed might soon stop hiking rates.

Overall, markets did not move much this week. The Nasdaq 100 posted a 0.49% loss while the S&P 500 was almost unchanged and is still in the vicinity of its 5-year high. As for the Russell 2000, it lost 0.98% on the week. All three indices remain above both their respective 50-day and 200-day exponential moving averages (EMAs). Our Buy signal remains in effect.

Trend Timing School

The impact of lower bond prices on the stock market

After being in a bull market for years, bonds have taken a bearish turn last summer as prices on long bonds have been coming down since then. We don't know if this is temporary or if, as many analysts predict, this represents the beginning of a long-term trend for higher rates and lower bond prices. Nevertheless, many are dusting off old theories and historical stock market data to affirm this is very bad news for the stock market. Some are even using the turn of events to predict a market top in equities or even an upcoming crash.

The historical event these theories most frequently point to as evidence of impending doom is the 1987 stock market crash depicted in Chart 1 below. The 30-year U.S. Treasury bond yields, from highs above 15% in 1981, steadily declined sending prices higher in a bond bull market that lasted through early 1987. Then, in April of that year, the yields began a ferocious ascent that would see them gain almost 3% in less than 6 months, and the bottom fell out of the bond market as prices tumbled. Many see the bond action as one of the major causes for the October 1987 stock market crash which, ironically, caused bond prices to rebound immediately.

Chart 1: Long bond yields and the 1987 market crash


This view is based on the currently prevalent belief that bonds and stocks move together. As interest rates fall both bonds and stocks move up, and when rates increase they both fall. We have written about the interaction of interest rates and the stock market before, see "Interest rates and the stock market". Just as stock prices lead economic activity, bond prices generally lead stock market trends, or so goes the thinking. This is generally true, but not always. The fact that disconnects in the respective movements of the bond and stock markets mostly happen at turning points is what leads a number of people to attempt to predict one with the other. If the bond market turns down, sooner or later the stock market should turn down.

Yet the bonds and stocks "in concert" relationship has not always been the case. In the pre-inflation days, before the nineteen seventies, common wisdom had bonds and stocks moving in opposite directions. Periods of economic expansion were good for stocks and bad for bonds, while recessionary phases were bearish for stocks and bullish for bonds. As interest rates increase, bonds become a lucrative alternative to stocks. As risk adverse investors see bond prices declining, their perception of risk of investing in equities increases, which in turn makes them less attractive.

Of course this notion of the bond market being a "safe" place to invest is not shared by those who lived through the inflation of the 1970s. Bond market safety is a myth because not only will their prices fall when interest rates rise, but at the same time inflation devaluates your bonds' purchasing power.

Despite all the top calling from the pundits, a number of market indices are still making new all-time highs. We don't know if we are close to a top or not because it is not possible to predict major trend changes in the bond or stock markets with any degree of reliability. As Trend Timers we always want to participate in all meaningful market moves and avoid significant declines.

As William O'Neil, of IBD fame, states wisely in his latest book ("How to Make Money in Stocks: Desk Diary 2005")"Cardinal rule #1 is to sell short only in what you believe is a bear market, not a bull market." To make sure we do, we will ignore the bond market as a prognosticator and let the stock market itself tell us when the broad trend has changed.

FAQ of the Week

Question: What is the impact of the settlement period on trading?

The settlement period is the time it takes your broker to finalize your orders. The trade date is when your broker executes the trade and the settlement date is when ownership of the shares actually transfers from the seller to the buyer, and when money and shares officially change hands. For buy transactions the settlement date is when your payment must reach the broker, and for sells it is when your broker credits your account for the sale. The settlement period varies between investment types but it is typically three business days for listed equities, and can be as short as one day for certain mutual fund transactions. Most investors never become aware of the settlement period because they either have enough cash in their account to cover the trades, or they have a margin account and their broker is more than happy to loan them money, unbeknownst to them in most cases, at a fairly stiff margin rate (currently as high as 10% with most brokers).

The reason this could be important for Trend Timers is that depending on the circumstances you may not be able to execute both trades on the same day. Remember that when you follow a Long and Short strategy each of our signals usually triggers two separate trades. The situation mostly arises in retirement accounts where no margin or short trading is allowed. Let's say you like to use an ETF such as QQQQ or IWM to go long and an inverse mutual fund to go short. Selling the ETF takes three business days to settle, which means that unless you have sufficient cash in the account you have to wait before buying the mutual fund. Note that not all brokers behave the same way. For example, if you tried to buy a security without sufficient cash in your account on the trade date, some brokers would not let you proceed and would warn you that such an order would be in violation of the IRS code. Other brokers would let you do it anyway realizing that you have the proceeds of another order pending.

The best way to avoid such situations is to optimize the type of trading and investment vehicles you use in your retirement accounts. If you are willing to live with the risk of occasional underperformance these vehicles have shown at times (see "More on ETFs versus bull/bear mutual funds"), exchanging between bull/bear mutual funds of the same family eliminates the effect of the settlement period.

Warm wishes and until next week.

The TimingCube Staff