TimingCube - Erratic markets - Hulbert Interactive results, trendless markets, trend timing and bear markets

Signal Type

Trade Date

Return since issued

World

U.S.

Nasdaq 100
(QQQQ)

Russell 2000
(IWM)

S&P 500
(SPY)

Market Update

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 Service" page for all the details.

Our current Cash signal remains in effect.

Trend Timing School

Erratic markets

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 to whipsaws.

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 (through 9/5/2008)

Strategy	Return %
TimingCube, Nasdaq 100 Long & Short	-7.15
TimingCube, Russell 2000 Long & Short	-4.82
TimingCube, S&P 500 Long & Short	-9.76
S&P 500 Buy & Hold	-15.02
TimingCube World ETF Long & Short	-16.45
TimingCube World ETF Buy & Hold	-35.84

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 the TradeGuru 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:

Stay true to our Trend Timing principles of delivering a 100% mechanical system
Focus on mid-term trends for infrequent trading
Not engage in curve fitting or other tempering with historical model behavior
Insure that enhancements improve the entire backtested period

For now 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.

FAQ of the Week

Question: 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 the Funds.

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