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

Market Update

After four consecutive weeks of gains, stocks marked a pause and remained little changed over the 5-day span. Investors booked profits the first two days of the week, taking a no-risk approach ahead of the much-awaited Fed's decision on interest rates, causing stocks to retreat modestly. Not surprisingly, the Central Bank announced Wednesday that there was no change in policy and that it was therefore leaving interest rates unchanged. The Fed also noted that economic conditions have been improving of late. The news supported renewed optimism among market participants, who stepped in to push the main averages higher on heavy volume, yielding the Nasdaq Composite a 1.5% daily gain. Despite news that weekly jobless claims rose and that July retail sales were disappointing, stocks tacked on more gains during the next session, before selling returned Friday following a worse-than-expected reading on consumer confidence. The main indexes dropped on the news but a late-day recovery helped the S&P 500 limit its loss to 0.8%.

The S&P 500 (SPY), Nasdaq 100 (QQQQ) and Russell 2000 (IWM) respectively lost 0.41%, 0.63% and 1.19% over the five-day span. All three ETFs remain located above both their 50-day and 200-day exponential moving averages (EMAs).

For its part, our World portfolio posted a 0.68% loss this week. The portfolio consists of the 5 top-ranked world ETFs as of July 17, which marked the beginning of the current 4-week holding period. Please note that the World portfolio is being rebalanced today, as the current 4-week holding period is now over.

Our current Buy signal remains in effect.

Trend Timing School

The dismal performance of mutual funds continues

The results are in and mutual fund managers continue to struggle mightily to keep pace with the S&P 500. Fewer than 30% of mutual funds managed to outperform the market from 2003-2008. This gap in performance is not new and is quite consistent with past periods. In John Bogle's Little Book of Common Sense Investing (Wiley 2007), the case is made for avoiding actively managed mutual funds and sticking with passive index investing. Mr. Bogle, the founder of Vanguard Mutual Fund Group, extends his argument to say that investors should focus on keeping costs low by reducing commissions, avoiding and/or lowering fees, and minimizing the tax implications of their investment strategies.

The key data behind Mr. Bogle's argument is as follows:

1) Plugging decades of investment returns into a Monte Carlo Simulation suggests that very few money managers will be able to consistently beat their investing benchmark - typically the S&P 500 or some subset, such as the S&P 600 mid-cap index.

Chart 1: Odds of Actively Managed Portfolio Beating Benchmark



2) Mr. Bogle then compares actual data over 35 years (from 1970-2005) to that theoretical simulation finding that reality does indeed mirror theory. Over the 35 year period measured, only 9 of 355 funds in existence throughout that period beat the S&P 500. Of those 9 funds, only 3 showed consistent performance, the other 6 funds having strong periods here and there but somewhat limping into the latter phase of the test period (usually because they attracted so much investor money that outsized returns became harder to achieve). Nine of 355 is a 2.5% rate of success among active mutual fund managers, quite in line with the simulation's 2.00-5.00% success rate estimate. The lesser amount, 3 of 355 with consistent success, is a dismal 0.8% of all mutual fund managers. Thus, 99.2% of mutual funds FAILED to improve upon just buying an index fund and tracking the market.

3) With such scarce excellence among mutual fund managers, would investors even be able to find these outperforming managers? Like finding a needle in a haystack, to say the least! Bogle, of course, argues that the odds of identifying these managers is all but impossible. If you are lucky enough to find them, your task is further complicated as you must do so before their fund peaks and begins the inevitable slide toward mediocrity.

Returning to the more recent data: through the end of 2008, the five year performance of active mutual fund managers is better than Mr. Bogle's simulated results would suggest, but still disheartening for investors.

Table 1: Mutual Fund Performance (2003-2008)

Fund Category	% Beating Benchmark
All Active Managed Funds	28%
Mid-cap Funds	24%
Small-cap Funds	15%
Fixed Income Funds	<10%

Of interest, this period included a strong bull market from 2003-2007 as well as the crashing market of 2008. Thus, managers had every opportunity to put away big gains in 4 of the 5 years while playing defense to protect gains in 2008. Of course, that is not what they did. The herd mentality that is so pervasive when it comes to most human endeavors holds particularly true in pursuit of investment returns. Last October, after the market crashed under the weight of the Lehman Brothers failure, a huge number of mutual fund managers effectively doubled down on stocks, believing the worst was over. It was not. And their returns suffered for that misstep.

Meanwhile trend followers were happily sitting on the sidelines in cash or perhaps even profiting from the downtrend in stocks.

John Bogle's book argues that investors should just buy and hold the market. He rails against the marketing practices of large brokers like Merrill Lynch who sell their unwitting clients consistently underperforming funds while pocketing excessive fees. Note that Mr. Bogle is not taking issue with their buy and hold mentality, rather he just doesn't think investors should pay extra for poor mutual fund performance. Thus, the investment industry broadly continues to market buy and hold as the key to investing success. And continues to charge and pocket fees for failing to deliver growing investor portfolios.

Here at TimingCube we continue to marvel at the inability of many investors to learn from past pain. We meet investors every day who continue to buy into the "can't time the market" mantra that large investment houses espouse. By selling fear, they keep investors locked into losing formulas and high fees. We are glad so many of you protected your wealth along with us last year. We obviously side with Mr. Bogle in recommending the benefits of investing in indexes. But we absolutely believe investors can perform much better than the market, and our history proves it.

 The Little Book of Common Sense Investing: The Only Way to Guarantee Your Fair Share of Stock Market Returns (Little Books. Big Profits)
A book by John C. Bogle

FAQ of the Week

Question: Why are investment firms dropping leveraged and inverse ETFs?

Recently several large investment firms have changed their policies regarding use by their brokers of leveraged and inverse ETFs. In most cases, they have forbidden their brokers and reps from investing client money in these ETFs. This change of heart comes from the poor performance of inverse leveraged ETFs, such as the SRS (ultra short real estate ETF) during last fall's extreme market volatility. We have written for years about the impact of negative compounding from leveraged ETFs. Apparently, the large investment houses and their brokers/reps didn't read our notes . Compounding a return every day works wonders during a nicely trending period. But extreme volatility causes returns to diverge dramatically as time goes on, even to the point of turning a profitable trend into a heavily losing investment (for more details about negative compounding read our Weely Update sent on 10/20/2006). Such was the case last fall as markets whipped up and down in unprecedented fashion. To react to this market extreme with such a change in policy strikes us as very short-sighted. We think that firms such as UBS who have now outlawed inverse ETFs are setting their clients up for further failure when the next bear market grabs hold of their portfolios. They will have one less arrow in their quiver to protect their investors. A more sensible approach would be to educate their brokers and reps about the benefits and costs of these investments so they can use them more effectively next time around. Did they similarly outlaw tech stocks when they crashed in 2002 and laid waste to so many portfolios? Don't think so. At the root of this policy change perhaps is the swift market share gains of Proshares, gained by offering these products during a raging bear market. This success led competitors such as Barclays (who recently sold their ETF business) to actively dispense "research" papers decrying leveraged ETFs. We think it was the ill-informed brokers and reps who were at fault here and now their clients will ultimately pay the price. A more sensible approach has been taken by firms such as Fidelity who has simply issued notes outlining that investors take care when investing in leveraged ETFs. Investors must recognize that one must pay more attention to them, especially during highly volatile markets. Shouldn't that always be true (and obvious!) when investing with leverage? Anyhow, we are certainly biased as leveraged and inverse ETFs has served well our simple approach to investing. We are thankful that Proshares has made life so easy for our subscribers to take advantage of our signals. Ah, were it so easy for UBS clients to profit .

Warm wishes and until next week.

The TimingCube Staff