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

Market Update

All major averages lost ground over the five-day span, with most of the losses coming in the first two days of the week. On Monday, stocks gave back most of last Friday's gains as concerns over the sheer scale of the proposed $700 billion government rescue plan sent the dollar lower and oil prices higher, the cost of a barrel of crude jumping over $16 on the day. Stocks plunged as a result, with the Nasdaq Composite posting a 4.2% daily loss. Weakness continued Tuesday, as Treasury Secretary Henry Paulson and Fed Chairman Ben Bernanke presented the government's financial bailout proposal to Congress. With both Republican and Democratic lawmakers voicing concerns and casting doubts over the plan's future, investors chose to sell, sending the S&P 500 1.6% lower. After a quiet session Wednesday, optimism returned to the markets early on Thursday on hopes that lawmakers were about to approve the financial rescue plan. Stocks jumped higher as a result but relinquished part of their gains by day's end as no deal could be cut in Congress. The markets remained under heavy pressure Friday morning following news that Washington Mutual had just become the largest U.S. bank to fail, as its assets were seized by federal regulators and sold to JPMorgan Chase. The large-cap indexes were able to recover and finish in the black after congressional leaders provided assurances that an agreement will be reached over the government rescue plan. The Nasdaq 100 still lost 0.92% on the day as tech stocks remained weak, following a disappointing earnings report and grim outlook from Research In Motion, which caused the company to lose 25% of its market capitalization.

For the week, the S&P 500 (SPY), Nasdaq 100 (QQQQ) and Russell 2000 (IWM) respectively lost 2.63%, 4.24% and 5.63%. All 3 ETFs are again located below both their 50-day and 200-day exponential moving averages (EMAs).

For its part, our World portfolio posted a 4.64% loss this week. The portfolio consists of the 5 top-ranked world ETFs as of September 12, 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

Value style is back in vogue

We have discussed many different approaches to classifying and segmenting the stock market, including by geographies, industry sectors, and by company size (market capitalization). Today we look at the market by company style. For bonds, style is defined by maturities and credit quality. For stock funds, value/growth characteristics determine the style. Our broad market trend model and signals are style agnostic, meaning that we encompass all the companies in the Nasdaq Composite index (2,995 of them at last count) regardless of value or growth style. The reason we like to look at the style groupings is that they are good indicators of the general market cycle, and recognizing the shifts in style trend can offer enhanced profit opportunities.

Market students have long observed that bull markets regularly consist of two distinct phases, each with their different characteristics. In particular, the first phase tends to be dominated by value stocks and the second by growth oriented issues. Similarly, small cap stocks tend to lead the first phase, while the large caps take charge during the second phase.

One reason this could be important is that over the last 20 years, small caps companies considered of the value type had annualized returns of 15%, better than the S&P 500 at 13%, and better than any other stock segment. But if it was possible to time when these small cap companies are outperforming and when they should be shelved, one could do even better.

But first, let's look at the definitions. A value stock is what a value investor considers an undervalued company based on fundamentals such as dividends, earnings, sales, etc. These companies have low price/earnings (P/E) ratios and/or high dividend yields. The theory is that an abnormal undervaluation will ultimately be corrected and profits will be made in the process. On the other hand, growth stocks are the ones whose earnings are expected to grow faster than average as compared to the rest of the industry. A growth investor does not care so much about price as he does about maximizing capital gains. Nothing comes close the capital gains achieved by growth stocks during the expansion phase.

A very simple approach to tell which phase we are in is to look at what the market is actually doing. In Chart 1 below, we can see that on a long-term view the trends, and trend changes, can be spotted quite easily. The chart plots the ratio of IWW (the Russell 3000 Value iShares fund) over IWZ (the Russell 3000 Growth iShares fund). When the line goes up, it means that value stocks are performing better than growth stocks. When the line declines it is growth stocks that are taking the lead. From the bottom of the last bear market in October 2002, value stocks have outperformed growth stocks for much of the bull market. Only in July of 2006, nearly 4 years into the bull market, did the trend reverse to favor growth stocks. And if the last two months are to be trusted, it looks like the value style stocks are back in vogue.

Chart 1: Relative strength of value stocks versus growth stocks



In the November 16, 2007 Weekly Update (see "Changing of the guard") we discussed company size, as expressed by market capitalization, and their cyclicality. It turns out that combining the company size and style attributes yields an even stronger indicator. In Chart 2 below, we use the ratio of IWN (the Russell 2000 Value iShares fund), the prototype "small caps value" fund, and IWF (the Russell 1000 Growth iShares fund) the model "large caps growth" fund. With these ETFs, the differences and relative potential gains are magnified. To wit, the return to strength of the small caps value category since early July 2008 is stunning.

Chart 2: Relative strength of small caps value stocks versus large caps growth stocks



During the 1990 to 2000 bull market, value stocks led the way through the spring of 1994 only to be utterly outperformed by growth stocks from there to the peak in 2000. We all know what the bursting bubble did to the growth stocks afterwards, and history should serve as a constant reminder that it is wise to heed the market cycles. Somewhere in the middle of the tempest, it is comforting to see that all is not just utter chaos. There is some method to the madness. Markets repeat age old cycles.

Does the fact that small cap value stocks seem to be back in favor mean that the bear market is over? Not necessarily, but these charts are great to show, with the benefit of hindsight, how the long-term trends evolve. Still, since these trends generally last from many months to years, it makes it possible for the astute trend follower to identify a trend early enough to ride it for profits. Practically, it means that during Buy signals, the currently favored style will tend to outperform the market as a whole.

FAQ of the Week

Question: Any impact from the new "naked short" rules?

On Wednesday September 17, 2008, the U.S. Securities and Exchange Commission (SEC for short) moved to curb illegal naked short selling by issuing new rules. Although no official text for these rules has as yet been made available, the intent is clear. Under the new measures, short sellers and their broker dealers must deliver securities by the close of business on the settlement date, three days after the sale.

Normally, a short seller must borrow real shares to be sold. A "naked short" sale takes place when an investor sells stock that has not yet been borrowed. This can result in situations where there are many times more shares sold short than there are shares of a given company, which should not be possible if the borrowed shares were delivered.

If the stock valuation plunges experienced by Freddie Mac and Fannie May (which were under a similar temporary SEC rule at the time) and Lehman Brothers and AIG more recently are any indication, the companies that must go down will continue to go down even without the naked shorts. Many analysts believe that there will not be any real difference because the SEC is making naked short selling illegal that already is illegal. In fact, there is growing pressure for the regulators to do more, such as banning short selling altogether and reinstating the uptick rule which the SEC abandoned last year (see "Any impact from the short uptick rule removal?"). Much of these regulations directly or indirectly attempt to place the blame for the financial crisis with investors, when in fact the financial industry brought it on itself with their unsound business practices.

Warm wishes and until next week.

The TimingCube Staff