Signal Performance as of
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.
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
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
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
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.