Signal Performance as of
Even though there was no lack of action again this week, the market was
able to stabilize and the major averages remained almost unchanged
overall. Stocks posted solid gains Monday following news that the
government seized control of troubled mortgage companies Freddie Mac and
Fannie Mae. Broad based selling returned the next day amid renewed
worries over the housing and financial sector: sales of existing homes
plunged 3.2% in July, more than expected, and shares of investment bank
Lehman Bros. lost 45% of their value as talks of a possible capital
infusion by a Korean bank broke down. The S&P 500 lost 3.4% during the
session on heavy trade. Following a quiet session Wednesday, volatility
returned to the markets the next day: after an initial plunge caused by
increased concerns over the fate of Lehman Bros., stocks were able to
turn around and close in positive territory as reports surfaced that
Bank of America may be involved in a Lehman buyout. In similar fashion,
the main indexes opened lower Friday, but renewed strength in the
energy, utilities and materials sector helped them recoup their losses
to close flat on the day.
For the week, the S&P 500 (SPY) and Russell 2000 (IWM) respectively
gained 1.34% and 0.85% while the Nasdaq 100 (QQQQ) lost 0.05%. All 3
indexes remain located below both their 50-day and 200-day exponential
moving averages (EMAs).
For its part, our World portfolio posted a
0.54% loss this week.
The portfolio consists of the 5 top-ranked world ETFs as of
August 15, which marked the beginning of the current 4-week
holding period. The World portfolio is being
rebalanced today, as the current 4-week holding period is now
over. 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
page for all the details.
Our current Cash
signal remains in effect.
Here we stand, almost three quarters of the way through 2008,
with no gains to show for all our efforts. August delivered
yet another failed rally attempt and the corresponding aborted
Buy signal yielded
one more loss. And we are back in cash waiting for the market
to make up its mind. What gives? Have markets changed, is this
a new era? Is the trend following approach obsolete? We know
that some subscribers find this hard to take and we are the
first to admit that returns have not met our expectations or
our historical standards. Instead of looking for excuses or
rationalizations we endeavor to understand exactly what has
been happening, and review our approach and options.
Chart 1 below depicts the Nasdaq Composite's
ups and downs since the beginning of 2007 and overlays the TimingCube
signals. Not counting the Cash
signals, there were 8 signals issued during that time frame,
of which only 3 turned a profit when implemented with the World
Long & Short strategy. Not a very good ratio. The last
profitable trade was the January 7, 2008 Sell
and it only yielded 5.5%.
Chart 1: 2007 and 2008 challenging for trend followers
The chart tells us that we have been facing a market that switches
very quickly between up and down phases, without making significant
advances/declines in any of them.
Ideally you would like to call the tops and the bottoms, which
we all know is impossible. No one can consistently and reliably
predict tops or bottoms because they are made after the fact.
As market followers we do not worry about the market's unpredictability,
which we believe is a constant, but rather its unusual changeability
and inconsistency in the recent past. The sharp but short reversals
we have experienced repeatedly do not have enough amplitude
to detect and benefit from. In such conflicted markets no sustained
trend can develop, which makes trend following systems prone
Since we are for total transparency, here's how our various
strategies and services have performed so far this year:
Table 1: 2008 YTD performances of various strategies
Long & Short
Long & Short
Long & Short
500 Buy & Hold
World ETF Long & Short
World ETF Buy & Hold
When compared with the 15% loss of the S&P 500 our Long
& Short strategy using the main U.S. indexes at least
managed to pare the losses to single digits. The World
Long & Short strategy came in right behind the S&P
buy and hold with a 16% loss. Most telling of the reversals
that can be experienced during bear markets, and probably the
best advertising for the use of a timing signal, however imperfect
it may be, staying long the strongest but most volatile world
markets with the World ETF Buy & Hold strategy
resulted in a nearly 34% plunge so far this year.
The sad fact is that nothing much has been making money of late.
To place these performances in perspective, for 2008 year-to-date
through August, out of 12,263 mutual funds (U.S. equity, International
equity and Hybrid funds), only 331 have a positive return. Of
those, 235 are specialty sector funds, which leaves fewer than
100 diversified equity mutual funds that are positive for the
year. Using the Hulbert Interactive service as another data
point, it looks like almost nobody has made any money lately.
In fact, for 2008 YTD, barely 10% of the 182 investment newsletters
they track are in the green. Their best performer at 21.3%,
the Forbes Special Situation Survey, is a stock picking system
similar to our sister service TradeGuru.
While we are on the subject we might as well point out that
Folio A, with a return of 22.2%
through the end of August, would be ranked #1
on Hulbert if they tracked it.
So what can we do (besides switching to TradeGuru)?
The first reaction that comes to mind is to "fix the system"
by adapting the Model to new market conditions. We certainly
scrutinize our system relentlessly and always analyze its performance
and seek new ways to enhance it, but we cannot modify the Model
every time the market moves against us, this would be curve
fitting and would lead to more disastrous results over time.
Any potential improvements have to follow our stringent rules:
true to our Trend Timing principles of delivering a 100%
on mid-term trends for infrequent trading
engage in curve fitting or other tempering with historical
that enhancements improve the entire backtested period
we have not found enhancements which meet the above criteria.
And this includes looking for faster trends and longer trends.
One yields more whipsaws and the other larger drawdowns, and
neither does as well in all market conditions.
The bottom line is that when the market does not generate
any sustained trends, there are no trends to follow and no
money to be made. We take what the markets give. Much like
the fisherman depending on the sea to contribute fish, the
trend timer relies on the market to deliver the trends. Our
study of decades of stock market action tells us that the
only certitude is that it will keep on changing and going
through its cycles. Trendless phases are not new and they
do not last forever.
The best course of action for our investments is to stick
to our guns and be patient. A bear market is not a good time
to renege on Trend Timing.
How safe is an ETF from a fund sponsor collapse?
With the number of financial companies in bankruptcy or in need of bailout or other cash injection it is no surprise investors are wondering about the safety of their investments. For example, Lehman Brothers which has been dominating the news lately for all the wrong reasons has its name all over a number of ETFs, like TLT (the iShares Lehman 20+ Year Treasury Bond fund).
TLT being a bond fund it is not represented in our list of World
ETFs, but as an example it will do just fine. In this
instance, Lehman is really a non-issue because their only involvement
is to license their Lehman Brothers 20+ Year U.S. Treasury index
which the fund tracks, and collect licensing fees. In this case
the fund sponsor is Barclays Global Investors which does not
own the iShares Funds, but serves as an investment adviser to
One of the advantages of ETFs is that they represent a share
in underlying commodities or securities and any number of "qualified
participants" (i.e. market makers, large investors and institutions)
can create/redeem shares. As long as the underlying securities
have a value, the ETF retains its value. The bottom line is
that the value of an ETF is shielded from the collapse of the
fund sponsor or other market makers.
Note that this is a key difference between an ETF and an ETN
(Exchange Traded Note) which is simply an "I Owe You" with only
the credit worthiness of the issuer as guarantee, and this represents
a default risk not found in ETFs.
Warm wishes and until next week.
The TimingCube Staff