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

Market Update

It has been another week of heavy volatility, that the major averages finished slightly higher. Stocks failed to capitalize on last Friday's positive action during the first session of the week to instead resume their descent as worries over the depth of the European financial crisis intensified after Spain was forced to take control of one of its savings bank that was about to fail. The S&P 500 retreated 1.3% on the day. With growing tensions between North and South Korea adding to the negative mood, stocks kept plunging Tuesday morning. The S&P 500 briefly undercut its February low, but an afternoon rally allowed the index to recover all its losses to finish little changed. Inverse action could be observed the next day: stocks posted solid early gains following the release of better-than-expected durable goods and home sales data, but then turned around to finish the session with losses on rumors that China might reduce its exposure to the euro zone. The Nasdaq Composite shed 0.7% on the day and all major indexes closed at their lowest level since the correction started one month ago. Before the open Thursday, China dismissed the previous day's rumors by saying that it would stick to its European debt holdings. The news triggered a broad rally that allowed the S&P 500 to recapture 3.3% as stocks climbed all day. The gains occurred on lower volume, however, showing a lack of participation among institutional investors. News that consumer spending stalled in April and that Fitch downgraded the debt of Spain put pressure on stocks Friday, resulting in more losses for the S&P 500 as the large-cap index relinquished 1.2% during the last session of the month. Please note that the U.S. markets will be closed Monday, May 31 in observance of Memorial Day.

The S&P 500 (SPY), Nasdaq 100 (QQQQ) and Russell 2000 (IWM) respectively gained 0.24%, 1.69% and 1.81% over the five-day span. If both the Nasdaq 100 (QQQQ) and Russell 2000 (IWM) remain located in-between their 50-day and 200-day exponential moving averages (EMAs), the S&P 500 (SPY) still rests below its 200-day EMA.

For its part, our World portfolio posted a 1.24% gain this week. The portfolio consists of the 5 top-ranked world ETFs as of May 21, 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

Leverage pitfalls

You do not have the time to grow your nest egg, or the required starting capital? Not to worry. Leverage will supercharge your investments and let you leapfrog ahead. If we were guaranteed to get the perfect Buy/Sell signals (all timely and profitable), and that the investment vehicles we use to generate the desired leverage delivered perfectly on their promise, we could get very rich very fast. Don't believe it. That's a lot of ifs. The more likely scenario is that the market does not oblige, and instead of strong and well defined up and down trends, it delivers unpredictable stops and starts.

As always at the worst market junctures, leverage has become all the rage. The financial industry has built a whole new sector for derivative investment products, a new economy they say. Institutional investors, hedge funds and their wealthy sponsors have been reaping the benefits of highly leveraged strategies (unless the underlying happened to be real estate loans or interest rates, of course!). Investing on margin and leveraged derivatives have always been around for sophisticated investors. The trouble is that the new leveraged ETF products are so simple to use that innocent investors could be tempted to buy them, unsuspecting of possible consequences.

To be upfront about it, we have an axe to grind. We are not big fans of leverage and margin in general, and for the coming economic phase we believe that those with the least debt and leverage will do best. The odds are highly stacked against the big risk takers. Yes, when the next signal comes, be it a Buy or a Sell, we will jump in with both feet, but we will not invest more than we have, because we will never risk more than we have. There are numerous analogies in popular folklore to the leverage dilemma, such as "The Hare and the Tortoise". Very few paint the greedy and impatient as the winner.

To understand how margin investing works, let's briefly look at a specific example: if you have a margin account (retirement accounts do not apply) with $10,000, you could borrow up to the same amount from your broker to invest for a total portfolio of $20,000. That's what's called being on full margin because from your perspective you have borrowed a full 100% of your own capital. From your broker's point of view you meet the maximum 50% initial margin rule because you are on margin for 50% of your overall account value. If the investments you purchased increased by 30% in value by the time you sell, your portfolio is now worth $26,000 and $16,000 of that is yours ($26,000 minus the $10,000 you borrowed from your broker). This represents a net gain of $6,000, or a 60% return on your $10,000 investment. Without the margin trade you would only have gained $3,000.

BUT, if instead of increasing by 30% the investments you purchased lose 25%, the equity in your account would be $5,000 ($20,000 minus 25% = $15,000, minus the $10,000 you borrowed = $5,000). This $5,000 is about 33% of your $15,000 portfolio value, which would satisfy a maintenance margin requirement of 30%. Hopefully, we would have issued a new signal long before that happened, but the example illustrates how leverage so easily gets you to the brink of being wiped-out!

Some say that one way to simplify all of this and side-step many of these issues and risks, and circumvent the no margin trading in retirement accounts rule, is to instead use one of the numerous leveraged mutual funds and ETFs. Here are the various ways to apply leverage:

• Margin, 2x maximum
• Leveraged mutual funds, 2.5x maximum
• Leveraged ETFs, 3x maximum
• Options, 10x+

As you would expect the leveraged ETFs have the edge in simplicity, low cost and IRA compatibility. Great! What could be wrong with them? Just a few things:

• Leveraged ETFs available only for selected markets, few international ones
• You lose your money up to 3 times faster when the market goes against you
• Negative compounding could cost you dearly in trendless markets
• Compounded leveraged losses can wipe you out fast

Yes, we used to show results for "with Margin" strategies and, for the longest backtested periods, they tended to deliver the best results. This was misleading in many respects, and because we did not feel this served the best interests of the vast majority of our subscribers, we eliminated margin strategies altogether on the current version of the web site.

So, what is our specific recommendation? Most of us get enough volatility investing in the main U.S. markets and strongest world markets, without leverage. Should one be tempted to increase the risk/reward scales, we do not recommend exceeding an 80/20 ratio, or an 80% margin (which means 80% your capital, 20% borrowed capital).

FAQ of the Week

Question: Are ETF distributions and splits factored into your results?

The short answer is yes. Unlike indexes which ignore dividends and short/long-term capital gains distributed by their underlying companies, the IRS mandates that ETFs distribute substantially all their income and capital gains at least annually. The net effect is that from time to time, when the dividends are paid, the ETF price appears to drop in comparison with its index. For shareholders these distributions are not losses, since they receive the cash, but someone tracking performance purely with daily prices could easily conclude that the ETF is lagging its index. This is why all the ETF performance figures we publish on our site utilize so-called adjusted prices. Applying dividend and split adjusted historical prices to our ETF results reflects more accurately the returns our subscribers can realistically achieve when investing in the recommended ETFs.

For a more in-depth review of the mechanics and terminology associated with distributions and splits, including some actual examples, please read "ETF dividends and distributions".

Warm wishes and until next week.

The TimingCube Staff