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Signal Update
Current Signal Performance as of
Signal Type
Trade Date
Index
Return since issued
Nasdaq 100
Russell 2000
S&P 500

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Market Update
It has been a positive week for Wall Street. Following several consecutive down weeks, stocks were finally able to regain some of the lost ground, after last Friday's decision by the Fed to cut its discount rate by 50 basis points appeared to stabilize a very nervous market. Most of the gains occurred on Wednesday and Friday, as investors bet that the worst of the credit mess is now over and that the Fed will soon cut the funds rate to help the economy. Both assertions are of course open to debate. There are two important points to note concerning this week's rally: First, despite the gains of the past few days, all major indexes are still significantly below their July highs. Second, this week's rebound occurred on very low volume, clearly showing that many major players are not eager to buy shares at this level and are instead staying put, even though their participation is required if the gains are to be sustained.

For the week, the Nasdaq 100 gained 3.84%. The index is now back above its 50-day exponential moving average (EMA). As for the S&P 500 and Russell 2000, they posted respective gains of 2.31% and 1.64% on the week. Both indexes are located in-between their 50-day and 200-day EMAs.

For its part, our World Index Ranking portfolio outperformed its US counterparts this week as it gained 6.65%. The portfolio consists of the 5 top-ranked world indexes as of August 17, which marked the beginning of the current 4-week holding period. Please note that since we now have an active Sell signal, the World Index Ranking 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 indexes, as the strategy calls for staying invested at all times. Please go to our "Our Service" page for all the details.

Our active Sell signal remains in effect.

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Trend Timing School
The Plunge Protection Team

Somehow, the debate about government intervention in the markets reappears whenever a financial crisis looms, when approaching the end of an economic cycle or when the stock market is in danger of turning bearish. At one extreme are the free market purists who categorically reject any notion that the government might (or could) be tampering with markets, and at the other are the conspiracy theorists who believe that the government has some dark and secret market engineering plan. As usual the truth lies somewhere in between. The reason we care is that if there was such a thing as a "Plunge Protection Team" (PPT) and that if they were good at what they did, severe stock market declines would be history and so would Trend Timing.

Let's begin by disappointing the free market purists. Unless you have been living in a cave it has been hard of late not to notice the very loud and repeated pronouncements by the Fed and other officials, all explicitly aimed at "stimulating the markets" and "protecting the confidence in the system". If talk is not enough to convince you that the government is involved in manipulating markets, what about the rate cuts and liquidity ($64 billion at last count of reported injections) the Fed has pumped into the financial system over the last couple of weeks?

For disbelievers, there are some rather public and official tools in our government's vast arsenal, such as the Exchange Stabilization Fund (ESF). No, we are not kidding, and the fund's existence and goals are no secret. In fact the fund began operations in April 1934 with the stated objective of managing the value of the dollar on foreign exchange markets. We quote from the U.S. Department of Treasury's own web site (click on "Exchange Stabilization Fund"): "The ESF buys and sells foreign currency to promote exchange rate stability and counter disorderly conditions in the foreign exchange market. It is also used to provide short-term credit to foreign governments and monetary authorities". The latest financial statement dated June 30, 2007, courtesy of the same web site, puts the fund's total assets at $46 billion. That's a lot of money sloshing around in the name of stability.

The fact that the U.S. government at times acts to influence markets is no secret. At least some of the more visible and documented cases have come at times of crisis such as after the 1929 crash, the 1987 and 1997 crashes, after September 11, 2001 and of course the current credit crisis stabilization efforts. In each of these cases, the reported measures come in different forms but they all result in remarkable liquidity injections into various markets. The real debate is about the stock market and how much tempering the government really engages in, besides "jawboning" which is a time honored practice. Do they only influence indirectly with talk or by nudging interest rates, or do they actively engage in market operations?

The PPT originated quite officially by Executive Order 12631 signed by then President Ronald Reagan on March 18, 1988. The actual text of the order can be found in the National Archives (see "Executive Order 12631--Working Group on Financial Markets"). The establishment of the Working Group was in response to "Black Monday", the October 19, 1987 stock market crash. The stated purposes and function were "Recognizing the goals of enhancing the integrity, efficiency, orderliness, and competitiveness of our Nation's financial markets and maintaining investor confidence". The Working Group reports directly to the President and is composed of the Secretary of the Treasury (also the Chairman of the Working Group), the Chairman of the Board of Governors of the Federal Reserve System, the Chairman of the Securities and Exchange Commission and the Chairman of the Commodity Futures Trading Commission.

As far as we can tell, the term "Plunge Protection Team" (PPT) was first introduced in a now famous article of the same name in The Washington Post on February 23, 1997, by Brett D. Fromson (read the article here). He interviewed over a dozen past and present officials who have participated in meetings of the Working Group which leave little doubt about the group's objectives. The group's mystique is amplified by the fact that there is a concerted effort by the government to reveal the existence of the group, as exemplified by recent interviews given by its current Chairman Henry Paulson to the Wall Street Journal, but that all of the group's discussions and activities are kept rigidly secret.

There are numerous documented examples of suspicious market activity which many analysts and journalists believe are the deeds of the PPT. One recent such event occurred on August 1st when after being down substantially all day, the Dow Jones Industrials jumped 150 points during the last 20 minutes of trading for a positive reversal on the day, as did other major indexes. In this case the bounce was not tied to a short covering rally as is often the case. The rally later described by the press as "out-of-nowhere", was tracked down to a series of coordinated pre-placed electronic stock index futures buy orders from Goldman Sachs, Merrill Lynch, Deutsche Bank and Citigroup. Conspiracy theorists maintain that the PPT is footing the bill and calling the shots.

Where is the line between market stabilization and market manipulation? Most people would agree with the premise that one of the government's duties is to ensure the integrity of the financial system and that in order to do so they must intervene in the markets. While government influence is undeniable, it is our belief that it is not possible to change the nature of the markets and stop the economic cycle. Stimulations might help nudge, delay, or soften but they cannot stop a bear market from succeeding a bull market as they always have. Some experts argue that market manipulations in fact act like a rubber band which causes the ensuing market reaction, when it finally arrives, to be stronger than it would have been without intervention.

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FAQ of the Week
Question: Any impact from the short uptick rule removal?

No doubt due to more pressing concerns such as the developing credit crisis and the ensuing Fed stimulation efforts, the financial media has largely overlooked the fact that on July 6, 2007 the U.S. Securities and Exchange Commission (SEC) has officially abolished the short uptick rule. As a refresher, the uptick rule, also known as the "tick test", was put in place after the 1929 stock market crash to protect the investing public (Rule 10a-1 instituted in 1938). The rule stipulated that a short sale can only be executed at a higher price than a previous trade and was obviously meant to prevent short sellers from piling on to downward momentum and causing crashes. So, if the rule was good for 75 years, why is it not needed anymore and what consequences, if any, will come from its abolition?

We do not dare question the motivation for the SEC's underpublicized rule removal but to be frank, the rationale and the timing of the removal eludes us as it does many experts. The argument made endlessly by uptick rule opponents that "it did not prevent the 1987 crash" is easily rebuffed by "we'll never know how much worse the 1987 crash would have been without the rule, or how many other crashes it prevented".

In May 2005 the SEC began a year long pilot program to test the premises of the short sale price restrictions, in which it suspended all short sale price tests for a select group of over 1,000 equity securities. One of the few glimpses into the SEC thinking is provided in a speech by SEC Chairman Christopher Cox (read his Opening Statement on Eliminating the Short Sale 'Tick Test'). We quote: "The evidence gathered from the pilot suggests little empirical justification for maintaining short sale price test restrictions, at least for the exchange-traded stocks in the pilot."

One has to wonder about the validity of evidence, empirical or otherwise, that markets can be orderly without artificial mechanisms in place when the observation period is a 12 month uninterrupted bull market stretch without so much as a correction.

It seems logical that the elimination of the rule makes it somewhat easier for short sellers to exacerbate declines by selling into them, but on the flip side, this creates a larger number of shorts who will have to cover when buyers return. It is reasonable to believe that the rule removal can increase up and down swings. Since the rule elimination there has been a growing consensus, from traders mainly, that the change has led to significantly higher shorting activity and volatility, for small cap stocks in particular. Option traders have definitely noticed a shift in some indicators such as the NYSE Tick and volatility readings which are causing many program trading schemes such as swing trading to need adjustment. Others argue that recent increased volatility is caused by the subprime woes.

There is no obvious impact on our longer term Trend Timing system but we will continue monitoring the situation as traders adapt to the new circumstances.

Warm wishes and until next week.

The TimingCube Staff

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