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Turbo Model

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

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Market Update
After weeks of solid gains to record highs, equity markets were due for a breather. Monday set the tone for the week with a broad decline on rising volume. Continuing crude oil price surges and mixed earnings reports kept the slide going through Tuesday. With only a few technology companies such as IBM, Intel and Yahoo announcing earnings that beat street expectations as the good news in the face of daily oil price records and mounting tensions between Turkey and Kurdish rebels in Iraq, most were surprised to see earlier losses mostly erased by the end of Thursday. Then Friday came, with a vengeance. In the end, investors got spooked by oil's records streak, including the psychologically important $90 per barrel breached for the first time on Friday, as well as renewed credit concerns. Major sell-offs ensued across the board on higher volume on this options expiration Friday.

For the week, the Russell 2000 small cap stocks led the way down with a 5.04% loss, followed by the S&P 500 (-3.92%) and the Nasdaq 100 (-2.15%). The Nasdaq 100 managed to stay above its 50-day and 200-day exponential moving averages (EMAs), the S&P 500 dipped under its 50-day average and the Russell 2000 succumbed and finished below its averages.

The World Index Ranking portfolio ended just shy of the domestic indexes with a 2.12% loss during the first week of the current 4-week holding period. The portfolio consists of the 5 top-ranked world indexes as of October 15, the beginning of the current period.

Despite today's sharp pullback, our current Buy signal remains in effect.

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Trend Timing School
Dumping the greenback

Currency valuation is frequently associated with interest rate differentials and much has been made of the Federal Reserve interest rate cut last month having reduced the yield advantage of U.S. fixed income assets, and in turn hurt the dollar. This week reminds everyone that the dollar's fortunes are also influenced greatly by foreign capital flows.

Already negatively biased by the International Monetary Fund (IMF) declaring that the U.S. dollar is still overvalued, the greenback took a tumble to new all-time lows on the U.S. Dollar Index and against the Euro on the news that the Treasury International Capital (TIC) data for August were the worst in U.S. history. We do not usually dedicate Trend Timing School articles to news related events, but the fact that net foreign purchases of U.S. long-term securities were at minus $85.5 billion (i.e. they sold that much more than they bought) is, at best, a solid warning that the foreign trust in U.S. paper assets is declining, and this is bad for the dollar and long U.S. Treasury bonds.

Taking the Treasury Department report's bottom line "Monthly Net TIC Flows" figures which include short-term transactions as well, the shortfall for August was a staggering minus $163 billion. In the chart below we have plotted the TIC against the inverted Trade Balance for illustration of the problem. The orange line shows a fairly stable trade deficit for goods and services which totaled $57.6 billion in August 2007. The blue line plots the net International capital flows.

Net International capital flows versus trade balance

Sources: U.S. Department of the Treasury, U.S. Census Bureau

During that same month of August, Japan, China and Taiwan all were net sellers of U.S. Treasuries. Not only did they not buy their usual take, but they sold even more than they bought. Japan and China are frequently the largest buyers of U.S. Treasuries but, more importantly, they are also the largest holders of U.S. debt, and U.S. authorities are not anxious for them to start unloading. Just during August, Japan cut their U.S. debt holdings 4% to $586 billion and China by 2.2% to $400 billion. Overall, the selling of U.S. Treasuries in Asia resulted in the biggest monthly outflow ever.

A number of Asian countries, including China, Singapore and South Korea, have clearly announced their intentions of reducing the dollar exposure of their foreign reserves by setting up so-called sovereign wealth funds. These funds are intended to invest excess foreign-exchange reserves from export revenue to improve returns. In clear this means they will sell the U.S. Treasuries to invest in non-dollar denominated assets.

The reason all of this matters is that when the TIC (blue line) is below the level of trade deficit (the orange line) as they were in August, net capital flows are insufficient to fund the balance of trade. Such imbalances cannot continue for very long. The August numbers have no doubt been exacerbated by the subprime fiasco beginning to unfold then and, yes, it is possible that the August TIC numbers turn out to be a fluke. Still, there is a growing fear in economic and monetary circles that if this situation was to persist for a few months the consequences for the dollar could be major.

We have reviewed the dollar's precarious position both technically and fundamentally in these pages but the current events have more to do with the psychology of foreign buyers of U.S. debt. Many say that the biggest holders have the most to lose from a stampede out of the dollar, but it is clear that they are increasingly balancing the potential loss in value if they aggressively sell against possibly massive devaluation if they keep them. Ultimately, the fate of the dollar rests on the willingness of foreign entities to keep funding the financial follies of the USA. This willingness is largely dependent on their belief in the future value of the dollar and the continued credit worthiness of the U.S. government.

Ironically, many on Wall Street rejoice at the prospect of a weaker dollar. The reasoning is that a weaker dollar favors American companies that export, as their products and services become more affordable, and it boosts non-exporting American companies because the imported products and services of their foreign competitors become more expensive. All of this is expected to translate into higher profits, which is bullish for stocks.

Let there be no confusion, we are not monitoring the tribulations of the U.S. dollar for any actionable cues about the stock market trend because, as explained in the FAQ of the Week below, there are none. As investors, it is paramount to have such currency trend information in order to protect our portfolios. For specific steps to take, we suggest reading "Dollar proofing your portfolio" and "Honest money".

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FAQ of the Week
Question: Does economic or monetary data play a role in your Model?

No. Economic and monetary indicators commonly used in fundamental analysis, such as employment levels, Treasury International Capital (TIC), the money supply, interest rates and currency fluctuations play no direct role in our Model. Instead, we are trend followers and we listen to the market itself. We use technical analysis methods to recognize the primary trend, primarily by observing price and volume movements of the Nasdaq Composite index. Similarly, the World Index Ranking which targets the 5 strongest markets is 100% mechanical and based on technical analysis.

Warm wishes and until next week.

The TimingCube Staff

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