TimingCube - The Trend is contagious - market correlation,major indices,zones of trading,synchronicity,market volatility

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A few observing souls may have noticed what blew right by the rest of us: The Weekly Update notification e-mail now lists the titles of the Trend Timing School and FAQ of the Week articles. Some titles might even hint at their contents.

Signal Update

Current Signal Performance as of

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

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
QQQ

Note: QQQ returns are included for continuity sake.

Market Update

Markets started the week by moving higher, still carried by last Friday's positive employment report. Once again, the move occurred on very light volume as institutional investors remain on the sideline. A sell-off followed on Wednesday on increased volume, before markets stabilized on Thursday, the last trading day of the week, as markets were closed on Friday to honor the memory of President Ronald Reagan. The Nasdaq 100 and the S&P 500 respectively gained 1.80% and 1.24% on the week, while the Russell 2000 was basically unchanged.

There is no change for us this week and our Sell signal is still active.

Trend Timing School

The Trend is contagious

We have written about market correlation on several occasions (read " "), but since we introduced the "Performance by individual security or index" feature on the "Result" page you can prove to yourself that the correlation of world markets is not a myth by comparing various world indices and see that for most the results following TimingCube's Long and Short strategy would generally have outperformed Buy and Hold, a good indication of correlation. Global correlation is at the same time a fairly intuitive concept yet misunderstood and ignored by most.

Since the advent of telecommunications, it has been a well accepted fact that markets tend to cluster around so-called "zones of trading synchronicity" within which most markets are open simultaneously, and with almost no trading overlap between clusters. The clusters, defined by their geographic location around the globe and their general time zones are Americas, Asia, and Europe. The simple logic here is that events, news, action in other markets are all known virtually instantly thus influencing the investor mood while markets are still open. Critics argue that there is a big leap from this to conclude that the same phenomenon works around the globe and around the clock.

Prior to the October 1987 market crash and its aftermath, hardly anyone was talking about, and much less studying, the correlation of stock markets. Then, when markets across the globe fell almost in unison, people noticed, and since then there has been a lot of research conducted, theories devised, and empirical evidence accumulated as to the existence and underlying reasons for the global connection. There have been many mathematical models constructed to explain the behavior of markets including the market gravity model that proposes that markets "attract" each other as a function of their size, the "follow-the leader" variant, and also the global contagion model which tracks and predicts how an "infection" progresses across the world markets.
All this research had many diverse results, but the broad conclusions reached almost universally were:

Correlation between world markets is increasing over time
Longer windows of observation increase the correlation
Correlation increases with market volatility

More than before we live in an interconnected world, with real-time news accessible just about anywhere on the planet and computers feeding each other data non-stop. Regardless of why, there is plenty of evidence that even localized events can have a global impact on the world markets. Certain drops can be seen following catastrophic events such as those on September 11, 2001. As depicted in the first figure below, key world markets were in a slowly falling pattern which got interrupted by the attack, causing a well synchronized lowest point around September 21, followed by a recovery to levels indicative of the previous decline.

In contrast there are major local events which mostly affect national or regional markets. These are the exceptions to the rule and the episodes one needs to watch for because they are the ones which can temporarily disrupt the global harmony by throwing some markets into a spin. A perfect example of such a local disruption occurred before and after the handover of Hong Kong from the UK to China back on July 1st, 1997, a very rare but now classic case of a pre-planned historical event. Usually they happen without warning. While such major geopolitical events can be severe and last several years, they can also remain strictly localized. The figure below shows that for years prior to the handover, the Hang Seng (Hong Kong's stock market) saw tremendous excitement and speculation about the prospects of a unified China. Shortly after the event itself, the air came bursting out of the bubble in a classic corrective over-reaction. It took another two years for things to stabilize and the Hang Seng to rejoin the rest of the world markets. The main point here is that yes, there are major events that can cause a market or regional markets to break ranks with the global correlation.

So if this global contagion is so pronounced and obvious, why isn't everybody exploiting it?
One reason may be that most have been looking for ways to exploit the differences between markets and not the commonality, or that the majority look for short-term correlation and trading opportunities. This is the stumbling block most statisticians run into: looking at the markets on a daily basis or even weekly, the results are inconclusive, one market goes up, another goes down with seemingly no rhyme or reason.

The Trend Timing Model developed by the TimingCube founders has the prerequisite long-term orientation and the sensitivity to detect changes in the broad markets in such a way that it captures the key inflection points in most world markets. This is why the one single Model and signal can reliably drive a globally diversified investment portfolio. There will always be differences between different stock markets, including the notions of rotation and relative strength. One should not confuse the amplitude of market movements with their timing. Knowing what the general trend is provides a solid investment plan for the majority of investors. Being able to tell in advance, consistently, which world markets will be doing best in the near future requires a crystal ball we don't have (yet).

FAQ of the Week

Question: What is the reference for the Cash signal and should I place stop-loss orders?

Our Model uses the Nasdaq Composite as the reference, and to be precise, we use the closing price the day we issue the signal. It closed at 1958.78 on 4/29/2004, the day our last signal was issued, which places the current 9% Cash trigger at about 2135. Note that the same Nasdaq Composite reference is also used for the 15% variety of Cash signals.

Now back to applying your own stop-losses. Setting your own stop loss orders can be wise as long as you understand that they are subject to be hit at a time when our Cash signal is not triggered. The particular investment vehicle you use might be more volatile than the Nasdaq Composite, and if you set them too tight even an intra-day spike could stop you out. The risk then is to be stranded on the wrong side of the trend if the market resumes in the direction of our signal.

As always, it is of course for you to decide if you want to apply your own stop-losses.

Warm wishes and until next week.

The TimingCube Staff