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

Market Update

Much of the week's market action was driven directly by the opposite moves of oil prices and the U.S. dollar. Worries about the health of the financial system resurfaced briefly on Tuesday when a number of banks and brokerage firms led by UBS and JPMorgan Chase announced yet more red ink. The news of inflation reaching a 17-year high as the July CPI jumps 5.6% year over year was interpreted as good news by investors. Even the armed conflict in Georgia which necessitated the shut down of oil and gas pipelines and endangered neighboring oil fields did not stop the continued fall in crude oil prices. On Friday the barrel of crude briefly reached the $111 level which had not been seen in over three months. Part of the decline is attributed to projections of lower demand down the road, but it was the rallying U.S. dollar which contributed the most.

For the week, the Nasdaq 100 (QQQQ), Russell 2000 (IWM) and S&P 500 (SPY) respectively gained 1.78%, 2.71% and 0.62%. The Nasdaq 100 and the Russell 2000 indexes have improved their technical posture above their 50-day and 200-day exponential moving averages (EMAs), while the S&P 500 remains slightly above its 50-day EMA but below its 200-day EMA.

For its part, our World portfolio underperformed the U.S. markets this week with a loss of 2.44%. The portfolio consists of the 5 top-ranked world ETFs as of July 18, which marked the beginning of the current 4-week holding period. Alas, most of these international positions suffered both from the U.S. dollar surge and the severe correction in commodity prices. The World portfolio is being rebalanced today, as the current 4-week holding period is now over. Please go to the "Our Service" page for all the details on rebalancing.

Our current Buy signal remains in effect.

Trend Timing School

USA to the fore

No, we are not referring to the Olympic games medal count but the relative strength of world equity markets. Observing subscribers have noticed an important leadership shift in the recent World ETF Rankings and that is the rise of U.S. markets to the Top 5. In the most current Ranking we have no less than 3 U.S. ETFs in the Top 5: QQQQ (the NASDAQ 100 Trust Shares fund), ONEQ (the Fidelity NASDAQ Composite Index fund), and MDY (the MidCap SPDRs fund). This has not happened in years. In fact, many subscribers had come to wonder about our patriotic commitment because our momentum market ranking has seen foreign markets dominate as the U.S. markets lagged significantly for most of the last 5 years. Long time Trend Timers know that our emotions and feelings play no role in our investment decisions. Our duty to you, the subscriber, is to report the facts without bias because history tells us that you are better off investing in the strongest markets, wherever they may be. When the strongest markets happen to be U.S. markets we are not shy to let you know.

Some, on the other hand, accuse us of unfairness by stacking the list in favor of the U.S. It is true that a full 25% of the list (8 out of 32 ETFs) represent U.S. indexes. And yes, there could come a time when all 5 positions in our portfolio are U.S. markets. While this may seem highly non-diversified, we feel it accurately reflects the world market realities. By looking at sheer market capitalization of the respective markets, with the possible exception of IWC (the iShares Russell Microcap Index fund) which qualifies on merit alone, the U.S. indexes are large enough to command such an allocation. And the different U.S. indexes define very distinct segments of the broader market.

Chart 1 below demonstrates the wisdom of the momentum approach. The chart plots the relative strength, as expressed by our World ETF Ranking, for QQQQ and EWK (the iShares MSCI Belgium Index fund) since 2000. While the two markets have been well correlated, meaning that they generally move in the same direction, their relative strength has been highly variable and diverging. For the last 3-4 years, the Nasdaq 100 index as represented by the QQQQ fund has lingered in the bottom quartile of the rankings, only to pick up steam since the beginning of last year. In contrast, the Belgian market, which on occasion visited the Top 5 during the QQQQ weakness, has seen a drastic change of fortune and now finds itself dead last in the rankings.

Chart 1: The changing fortunes of markets and their ETFs


Chart 2 in turn shows the actual performance of the same two ETFs over the last 3 months, and it tells the tale. While our relative strength indicator combines momentum readings over longer time spans than the chart, the effects of weakening/strengthening momentum are plain to see. All of this does not mean that you cannot have losing periods with the strongest ETFs, but it suggests that our chances of higher returns are substantially improved. In fact, the chart makes obvious that a fund in the Top 5 can have negative returns for the short or mid-term. When our trend following model signals an uptrend with a Buy signal, our chances of profits are better with the top ranked ETFs, even if they are the ones losing the least.

Chart 2: Recent relative performance of QQQQ and EWK


There are two possible scenarios from here. Either the recently detected uptrend develops into a sustained mid-term move during which the market leaders in which we are currently invested will perform the best, or the equity rally is short-lived and turns out to be nothing but a bull trap by turning down in short order. For this eventuality we can rely on our Cash or Sell signals to move us out of harm's way in a timely fashion.

We never presume to know the future and we cannot predict how long the current uptrend will last, which ETFs will be the strongest until then, or how far they will go. We just know that our wealth building prospects are best served by faithfully following the trend and by investing in the strongest markets, which currently means that 3 of 5 positions are invested in the good old U.S.

FAQ of the Week

Question: What are the real costs of option trading?

Following the last couple of Trend Timing School articles on options trading we received some feedback which suggests that by trying for clarity and simplicity we may have painted a distorted picture. The articles provided good information on the mechanics, benefits and risks of options but omitted to fully spell out the potential costs. We will attempt to rectify the situation here.

Besides the broker's commissions which are relatively small in percentage terms, there are two additional hidden costs of buying options which can be significant. The first one is the bid-ask differential which can be of the order of $0.15 for the QQQQ options discussed in the July 25, 2008 article example. The second contributor to cost is the time value erosion. On average, for the type of trading we presented in the same example, you lose about half of the time value of your options. The net result is an added 2-3% cost for each trade. Assuming 3 to 4 trades per year this can amount to 5-10% additional costs per year as compared to trading ETFs.

One solution to mitigate the problem is to invest a larger portion of the portfolio, such as 25-50%, using more in-the-money or longer term options. Such techniques can reduce the annual cost to the 2% range.

Warm wishes and until next week.

The TimingCube Staff