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Nasdaq 100
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Classic Signal
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World
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Stock market blahs carried from Friday into Monday with indexes once again giving up around 1%. Apple's new iCloud announcement proved disappointing to investors looking for something more and sending Apple shares back near the bottom of their trading range. Stocks bounced back early Tuesday though found reason by mid-day to give back the gains. Ben Bernanke's failure to embrace a QE3 plan was given as cause. Sour sentiment continued into Wednesday when the Fed's Beige Book of regional economic activity showed flat-to-decelerating economic growth in most regions of the country - the proverbial "soft patch". The Nasdaq Composite index gave up another 1% on the day. Thursday, stocks finally found buyers and delivered their first positive day of June. There was little news driving the fractional gains and volume was quite low behind the small advance. Investors chose to continue lightening their stock portfolios Friday with energy shares taking a heavy blow as oil prices fell back under $100 per barrel. Stocks limped into the weekend with their sixth consecutive losing week while the U.S. dollar and U.S. treasuries continue to benefit from the increasing risk-aversion.
Yet another down week lopped off 3.56% of the Russell 2000's(IWM)
value while the S&P 500 (SPY) and Nasdaq 100 (QQQ) gave up 2.16% and 3.03%, respectively. All three indexes remain below their 50-day moving average and are approaching their 200-day moving averages, though still rest just above that key reference line.
Our World portfolio lost 4.13% on the week as the U.S. dollar strengthened. We are now three weeks into our last rebalance on May 20. Please note that since we have an active Classic Model 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 Classic Model "Description" page for all the details.
Our Classic Model Cash signal and Turbo Model Buy signal remain in effect.
Anatomy
of a correction
With all indexes having broken below their 50-day moving averages
and decidely trending down, stocks are clearly in a correction.
Last week's Classic Model Cash signal confirmed the market weakness
we have been writing about in your Weekly Updates for awhile now.
Once a correction begins, do we have any idea what comes next? Do
stocks have to plunge inevitably downward until they get so cheap
that value investors hold their nose and step forward?
The oft-noted rule of thumb says that market corrections deliver
declines of 10-15%, with a 20% or greater decline moving the correction
into full-blown bear market territory. As outlined very simply and
effectively in the blog, efficientish.blogspot.com, a correction
has four key milestones:
- Steep Drop #1 - Typically this is kicked off by a steep, relentless
sell-off that lasts at least two days. The 14 day Relative Strength
Index (RSI) will hit 30.
- Recovery Rally - A multi-day V-shaped rally that falls short of
recovering the previous high
- Steep Drop #2 - Another sell-off that brings the RSI back to 30
- High Volume Reversal - A single trading day in which the market
starts flat, drops at least 1%, and then recovers to close flat
or higher
The chart below outlines a couple of corrections from last year.
Note that the May 10th "flash crash" created an apparent
1st visit to the RSI 30 point. However, in retrospect, it looks
like this was a false signal driven by the oddities of the flash
crash itself. We only say this in the sense that ignoring that two
day aberration, the correction last summer followed the typical
pattern. An alternate explanation would be that the correction was
severe enough to have three separate down legs rather than the normal
two.
Chart 1: Market corrections follow the drop, rebound, drop
pattern
Chart 2 shows a correction from the summer of 2006. This one is
of particular interest because it was later in a cyclical bull period,
somewhat close in cycle to where we are now, and resulted from the
shocking announcement that China wanted to slow down its growth
(sound familiar?). Every correction is different, of course, but
they do share similar attributes.
Chart 2: 2006 correction follows typical pattern
At this point in our current correction, stocks are only down 5%
or so from their recent peak. Thus, the current correction has been
rather mild even though it feels more significant. For daily market
watchers, this feeling of a more significant downtrend perhaps results
from the "correction of time" notion that we referred
to in a recent weekly update. Since peaking in mid-February, most
market indexes have churned back and forth in a fairly tight trading
channel. The first week of every month since - e.g. March, April,
May, and now June - has seen some selling, sometimes enough to suggest
a more significant downturn. But each time, stocks have reversed
course to head back upward to the top of their trading channel,
and sometimes sharply so. This has left investors who are looking
for the cleansing power of a good correction frustrated (as we detailed
in last week's Update).
Now, it appears the correction-seekers are finally getting what
they want. The S&P 500
is closing in on its RSI 30 point and
nearing its 200-day moving average at the same time. This will be
the average's first visit to this key technical reference point
in nine months. Most market observers would expect these two reference
points to provide at least token support.
But we all know the old saying about the market ... that it delights
in making fools out of the most people it can. The above guidelines
provide a broad-brush outline of how corrections behave. In looking
at many market pullbacks and corrections, there is almost always
something a little different to each one. But this guide helps us
know generally where we are in the process and what to look for,
rather than flying completely blind. For us TimingCube subscribers,
the Models provide the brightest light for our path. Our Classic
Model has never failed to keep us out of harm's way when markets
come tumbling down. For now, our more long-term Classic Model has
recognized the danger of the correction and taken its conservative
followers to Cash, while our Turbo Model is actively looking to
play the back-and-forth of this correction. Recognize what each
of these helpful models is trying to tell us, how they try to guide
you, and use them to their best advantage.
For previous Weekly Updates on the nature of market corrections,
take a look at the August 17, 2007 and February 12, 2010 Weekly
Updates.
Question:
What is the difference between an ETF and an ETN?
Exchange-traded funds (ETFs, for short) are very similar to mutual
funds in structure. They are just collections of securities, often
focused on a particular purpose - for example, U.S. large-cap stocks,
or oil and gas stocks, etc. When you buy the ETF, you are buying
a small piece of the entire portfolio of securities, just as when
you purchase shares in a mutual fund. The difference from a mutual
fund being mainly that you can trade ETFs throughout the day, just
like individual stocks, whereas almost all mutual funds trade only
at the end of the day. Because of this ability of ETFs to trade
throughout the day, investors have more control over when they enter
and exit the trade, which also gives them control over some of the
tax implications of holding the security. Mutual funds distribute
capital gains whenever they choose, not when you choose.
Exchange-traded notes (ETNs, for short) are structured more like
bonds in that they have a maturity date, but do not necessarily
pay interest like a bond. Because bonds and notes are contracts
dependent on the underlying issuer to "make good" on their
obligation, there is a chance that the issuer could default on the
note (the ETN). This is a very remote scenario, because even if
the underlying issuer were to go bankrupt, there would likely be
other firms interested in stepping in to take over the ETN obligation
and receive the management fees derived from providing the security.
Of more interest to some investors, there has arisen a tax difference
between ETFs and ETNs which has made ETNs attractive when buying
commodity-based securities, MLP-based securities, and anything that
is structured as a partnership (which many commodity-based ETFs
are). Rather than dive into the nuances of the tax difference, we'll
just point out that ETNs are taxed like a bond - interest is taxed
as regular income; gains are taxed when taken. Commodity-based ETFs
can be taxed as partnerships, which can lead to filing of K-1 statements,
changes in cost basis from "return of capital" rather
than simple capital gains, and various other nuances. There are
several articles detailing these differences such as this one on
MLPs that goes into great depth on the relative tax treatments:
http://etfdb.com/2011/more-thoughts-on-mlp-etfsetns/
and,
of course, one should consult their tax professional for help with
their particular situation.
The tax treatment differences are usually confined to commodity-based
ETFs and ETNs. Otherwise, most investors will notice little difference
between ETFs and ETNs on a day-to-day basis.
Warm wishes and until next week.
The TimingCube
Staff
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