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

Market Update

With the exception of small caps, stocks retreated over the five-day span. Yet, they managed to finish off their lows thanks to a solid rebound Friday. The main indexes attempted to move higher Monday morning on news that Hewlett-Packard and Dell are both trying to acquire storage company 3Par. The rally was short-lived, however, as stocks quickly reversed course to close in the red, with the Nasdaq Composite losing 0.9%. The selling continued in earnest Tuesday after the release of a disappointing housing report: existing-home sales for July hit their lowest level in 15 years, triggering a broad-based sell-off on heavy trade that left the Nasdaq Composite with a 1.7% loss by day's end. Stocks continued their descent early Wednesday following weaker-than-expected data on durable goods order and July new-home sales, before they turned around to finish with modest gains. Inverse action could be observed the next day, as opening gains quickly evaporated to leave the major averages with losses that more than erased Wednesday's profits. Spooked by a revenue warning from Intel and cautious comments from Federal Reserve Chairman Ben Bernanke, investors initially bid stocks lower Friday morning, sending the Dow Jones Industrial Average briefly below the 10,000 mark before a solid rally ensued that allowed the S&P 500 to recapture 1.7% by session's end. With markets oversold as a result of the recent decline, the bounce was not that surprising and was in part sparked by short-covering after the main indexes hit key technical levels Friday morning.

The S&P 500 (SPY) and Nasdaq 100 (QQQQ) respectively lost 0.62% and 1.89% over the five-day span. Small caps fared better, as the Russell 2000 (IWM) managed to finish the week 0.82% higher. All three ETFs are again located below both their 50-day and 200-day exponential moving averages (EMAs).

For its part, our World portfolio was flat this week. The portfolio consists of the 5 top-ranked world ETFs as of August 13, which marked the beginning of the current 4-week holding period. Please note that since we now have an active 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 "Our Service" page for all the details.

Our current Cash signal remains in effect.

Trend Timing School

Stock market, what ails ya?

The stock market's uninspired summer has shown little interest in getting off the porch. Markets have dropped back to summer lows and stand on the precipice of another leg downward despite a July earnings season that was reasonably good. Why the long faces? After all, we appear to have overcome the Euro debt storm (or have we?). Summer worry #1: fears of a double-dip recession, which we have chronicled always show up around this time in a new cyclical bull period. But we think the second set of investor concerns is holding more sway. As evidenced by the non-stop rally in all things bond-like, a rally that has gone on for five months now, investors are far more interested in safety. They are willing to accept exceptionally low yields because they believe stocks will go nowhere, perhaps for an extended period. Think about it. Investors have been willing to pour money, almost hand over fist, into assets that will yield 3-4% or less for the next few YEARS. For that to be attractive, you must believe stocks are a rather unappetizing alternative. For certain, investor psyches are fragile, damaged most recently by the May 6^th "flash crash". Individual investors have little faith in stock markets as a result. Thus, money flows out of equity funds and continues into bond funds. At some point, investors surely will begin to wonder whether stocks will really be unable to muster better than a 3-4% yield over the next three years. We suspect they will.

Chart 1: Investors can't get enough bonds



In the meantime, one of the key scenarios underlying the strength in bonds and corresponding weakness in stocks is a fear of deflation. Some readers will scratch their head thinking that it was just a few months ago that "experts" were touting how all the Fed printing of money would certainly cause massive inflation! What happened to that argument? It got revised, pushed out, and joined those who bet heavily that high government deficits would send U.S. Treasury rates soaring. The reality has been that U.S. Treasury rates have fallen steadily further while inflation has been non-existant.

Now, the herd mentality has flipped to a bet on a deflationary environment. In such a scenario, even low yields are a good return. Just as inflation harms fixed income investors by eating away at their returns, deflation helps fixed income investors by making their fixed income cash flows ever-more-valuable as prices fall. Being heavily in debt, however, during a deflationary period is not typically a good thing - as banks and many home buyers/investors experienced in 2008 (and still do).

We finance our assets through either equity or debt. The debt part is like a big immobile rock. The equity part swings up and down with the value of the asset. Thus, as the value of the asset declines, the equity declines while the debt holds firm. Assuming we cannot refinance our interest cost downward, the debt/interest burden eats up a bigger and bigger piece of our income/asset value until it becomes unsustainable.



In a broader economy, the problem with deflation or inflation comes if consumer/investor mindset fully embraces the notion. In an inflationary environment, consumers are incentivized to spend right away in order to avoid ever-rising prices and lock in the lower price. Of course, that rapid spending creates an inflationary spiral as consumer expectations for ever-higher prices actually causes those ever-higher prices. On the deflation side, expectations of ever-lower prices leads consumers to NOT spend money. Thus, prices either fall until they are so juicy buyers step in, or the business financial equation becomes unsustainable - e.g. they can't charge enough to cover their costs and the business fails. As an investor, if you believe that prices (in this case asset or stock prices) will keep falling, you are very willing to lock up the current yields, regardless of how low they may appear so that you at least get some return on your money. Such is the prevailing mood on Wall Street, especially among cautious individual investors.

How can this mood change? As always, uncertainty is the enemy of stock investors. In addition to economic uncertainty, investors are felled by a lack of clarity on tax policy (or expectation that rates will rise, which promotes selling rather than buying), questions about how growth outside the U.S. will play out, whether Europe's debt problems are really better (recent downgrade of Ireland's debt suggesting they may not be), and a lack of confident outlooks from corporations despite decent earnings. Come November, some of these uncertainties will have at least shifted, if not become somewhat more clear. We will have seen whether earnings are better than the cautious outlooks currently suggest. Elections will perhaps give investors a sense for whether the odds are better or worse for changes in tax policy. And Europe/Asia growth will either be firming up or slowing down.

In short, the market is playing the slowing down card heavily right now, expecting that stock prices will remain weak and yields, even at very low levels, are a better place to stash cash. Whether investors are being overly pessimistic right now remains to be seen. Our Cash signal keeps us protected while this nervousness persists.

FAQ of the Week

Question: Isn't this pause to digest last year's big stock gains normal?

Generally speaking, the current malaise affecting stocks is common during cyclical bull markets. Whether this market, with all its ills, repeats the past remains to be seen. A recent post by Marty Chenard at stocktiming.com provided a good high-level view of where we stand compared to other recent bull periods. Rather than spin Marty's public post, we'll just offer it to you verbatim below:

This is the third Bull Market since 1995. All of them, including this one, have one thing is common ... what is it?
A quick look at the rectangle areas on today's Monthly S&P 500 chart gives you the answer. A level of 1103 on the S&P has been a pausing and consolidation area for each of the three Bull Markets.
The behavior of all 3 Bull markets has been for our red trend line to finally pull back and touch the blue trend line during a sideways consolidation.
This Bull market has been no different because the trend lines are once again merged. So, this model is saying that we are at that "old familiar place" once again.
This is an important, historic area. The real question at this level is now this: "Will the current Bull market now end and turn into a Bear market, or will it continue on and make new highs?"
This is a monthly chart, so each bar represents one month of time. Historically, the process at this juncture has taken three to five months to resolve. This one has been going on for a while, so we are looking at a matter of only a few weeks before we see how this 1103 juncture turns out.

- (By the way, for the curious ... the trend line settings are as follows: The shorter term, red trend line is a 6 month Exponential Moving Average (EMA). The longer term, blue trend line is a 12 month Simple Moving Average (SMA).

Chart 2: Last 3 Bull markets


Source: www.stocktiming.com

Warm wishes and until next week.

The TimingCube Staff