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

Market Update

Stocks recovered a good chunk of last week's losses over the five-day span, but did so in unconvincing manner as trading volume remained low all week. This clearly shows that institutional investors largely side-stepped the rebound, raising doubts over the sustainability of the rally. With investors awaiting the Fed's decision on interest rates, the major averages remained little changed during the first two sessions of the week. Not surprisingly, the Central Bank announced Wednesday afternoon that it was leaving interest rates unchanged. Stocks, which had moved higher early in the session, relinquished all their gains after the Fed's announcement. A solid quarterly report from Cisco Systems combined with positive economic news, including lower weekly jobless claims, an increase in productivity and better-than expected October retail data, to send stocks markedly higher the next day. The Nasdaq Composite gained 2.4% during the session, but volume was noticeably absent from the move. In a sound market, such large market gains should be accompanied by rising volume, but it was clearly not the case Thursday. The Labor Department said Friday that 190,000 jobs were lost last month, significantly more than the anticipated 175,000, and that the unemployment rate rose to 10.2%, its highest level since 1983. The negative news was partially offset by analyst upgrades of General Electric and Amazon, allowing stocks to close modestly higher on the day, albeit on lower trade again.

The Nasdaq 100 (QQQQ) and S&P 500 (SPY) respectively gained 4.00% and 3.45% over the five-day span. Both ETFs have recaptured their 50-day exponential moving average (EMA), while the Russell 2000 (IWM) remains located below its 50-day EMA despite a 3.11% weekly gain.

For its part, our World portfolio outperformed its U.S. counterparts this week with a gain of 4.72%. The portfolio consists of the 5 top-ranked world ETFs as of October 9, 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

Small cap stocks as a proxy for investor risk tolerance

We recently wrote how this rally has climbed the proverbial "wall of worry". In October, investors shifted that worry into a more select form of risk aversion. By looking at the action of the Russell 2000 small cap stock index, we can gauge a key part of investor sentiment. This index is important because it's a good barometer of how much risk stock investors are willing to take. Small cap stocks are one of the most volatile and sensitive areas of the market. Their profits tend to reflect the underlying economic strength and its prospects, often in exaggerated terms. Thus, as the rally ran out of steam in October, small caps were among the first and most noticeable areas of the market to exhibit investor concerns.

Chart 1 displays the small cap index (Russell 2000) and a very large cap index (OEX 100). We can see how these two very different groups of stocks marched in tandem throughout the rally until early October. Then, for the first time since the rally began, small caps began falling at a noticeably sharper clip than the largest 100 stocks. This suggested money was fleeing from one of the riskiest areas of the market as concerns over the health of the rally increased. Confirming this change in investor sentiment toward heightened fear and safety was a spike in the volatility index (VIX) as shown by the dashed line.

Chart 1: Russell 2000 and OEX



Further evidence that money has been seeking safer harbor is the drop in the Money Flow Index to its lowest level since the bottom of the market back in March (see Chart 2). The Money Flow Index is quite similar to the RSI indicator we discussed recently but adds volume to the equation.

Chart 2: Money Flow Index and IWM



While we cannot know how long or deep this change in investor risk tolerance will be, we can examine key areas of support and resistance to frame what price levels might signify further weakness or a possible return to the uptrend.

Chart 3: Russell 2000 levels



Again focusing on the Russell 2000 we see clear areas of support and resistance for some of the riskier stocks in the market. As the Chart 3 shows, the Russell 2000 has thusfar held above 550. Any marked drop below that level would raise more questions about the near-term ability of the market to fully resume its rally. Similarly, a move above 625 would suggest a possible new phase in the rally and a substantial shift in sentiment back to riskier assets.

FAQ of the Week

Question: What is the composition of the Russell 2000?

With 2000 stocks, the Russell 2000 small cap index is certainly well diversified. You might be surprised to find that the index actually has a relatively small weighting toward more traditional cyclical industries. Energy and industrial sectors are relatively minor players while finance, healthcare, and technology occupy almost 50% of the index. It's focus on these largely service industries is a good reflection of the current makeup of the U.S. economy. Or perhaps tech and medical equipment makers are the new definition of "manufacturing"?

Chart 4: Russell 2000 breakdown



Warm wishes and until next week.

The TimingCube Staff