TimingCube - Changing leadership - Changing leadership, sector leadership, sector rotation, world market correlation, country leadership

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Signal Update

Current Signal Performance as of

Signal Type	Trade Date	Index	Return since issued
		Nasdaq 100
		Russell 2000
		S&P 500
		QQQQ

Cumulative Returns since First TimingCube Live Signal () as of

Index	Long Only	Long Only with Margin	Long & Short	Long & Short with Margin	Buy & Hold
Nasdaq 100
Russell 2000
S&P 500
QQQQ

Note: QQQQ returns are included for continuity sake.

Market Update

This week was widely expected to be one of consolidation, pullbacks and regrouping after the market's recent advance. If this was regrouping, the market exhibited very healthy action with only one losing session, and a mild one at that with the indices shedding about 0.30% on Tuesday. The strongest advance came on Thursday with the Nasdaq 100 gaining 1.27% in increasing volume. Even in the face of bad news, such as a new all-time record trade deficit for September and new terror attacks in Jordan, the market seems resilient. The dominating factor for the markets this week, again, was the continued slide in oil prices. With energy and construction stocks on the defensive, gains were surprisingly broad-based with new leadership continuing to emerge from financials, medicals, retailers, transports, and technology, especially the internet segment. The week ended sluggishly right on top of important technical boundaries, like 2,200 on the Nasdaq Composite index which could take a serious fight to overcome, a mandatory step for the markets to move higher from here.

For the week, the Nasdaq 100 advanced 1.56%, the Russell 2000 by 1.29%, and the
S&P 500 1.19%. With the week's apparent foundation building action our Model remains in a Buy mode.

Trend Timing School

Changing of leadership

Many of us watch and invest exclusively in broad U.S. stock market indices. Many of us miss out big time when broad U.S. stock market indices are in a slump. Stock markets go through endless repeating cycles which can be viewed as lots of independent up and down phases in individual markets or, more accurately, as leadership passing from weakening areas to strengthening ones. Maybe a little peek over the fence will help convert some of the many-who-miss-out to the virtues of diversification.

A fundamental tenet of our Trend Timing discipline is that most world markets tend to move together in broad intermediary trends, which enables our Model to guide our investments in various domestic and international vehicles. We introduced the market correlation principle for U.S. indices in "The power of diversification" and for international ones in "The Trend is contagious".

The reason correlation and diversification matter is that markets take turns in leading the parade. Leaders do not remain strong forever and sooner or later they are overtaken by another surging sector. Markets ebb and flow in many dimensions. Recent Market Updates are discussing the shift in industry sector leadership that is happening as we speak in the U.S. stock market. The Trend Timing School article entitled "Industry sectors" details the very subject of sector rotation and lists many available sector ETFs. There are also the diversification strategies aimed at reducing the risk of a falling dollar as described in the article entitled "Currency hedging".

There are shifts in market capitalization leadership. While large companies were all the rage in the 1990s, small company stocks have been doing much better in recent years as demonstrated by the Russell 2000. Even the style matters. Growth companies dominated the 1990s but value-type companies have been winning in recent years. For people with an opinion on the future style preference you now have ETF pairs dissecting the S&P 500 and Russell 2000 along value/growth lines (IVE/IVW and IWN/IWO respectively)

Last but not least, since it is the main focus of this article, we come to geographic diversification. As always a picture is worth a thousand words. Table 1 below lays out the 1-, 3-, and 5-year returns of various world indices. Surprisingly, IYE (the U.S. energy sector ETF which has been the hands down winner with 55% so far in 2005) has been surpassed by the Brazil country fund which is up 57.48% for the year.

Table 1: 1-, 3-, and 5-year returns of international stock markets indices
(when traded according to the TimingCube signal and a "Long and Short" strategy. ETF results may differ substantially)

Country	Index Name	Yahoo! Finance Symbol	Comparable ETF	1-year Return	3-year Return	5-year Return
Brazil	Bovestpa	^BVSP	EWZ	58.53%	193.17%	852.59%
Japan	NIKKEI 225	^N225	EWJ	45.58%	173.14%	316.65%
Mexico	IPC	^MXX	EWW	43.65%	146.29%	374.45%
Australia	All Ordinaries	^AORD	EWA	29.44%	83.14%	192.6%
Canada	S&P/TSX	^GSPTSE	EWC	27.77%	76.43%	251.27%
U.K.	FTSE 100	^FTSE	EWU	26.01%	75.5%	162.2%
Germany	DAX	^GDAXI	EWG	26.89%	186.25%	521.84%
France	CAC40	^FCHI	EWQ	24.04%	100.86%	257.72%
U.S.	Russell 2000	^RUT	IWM	8.84%	102.3%	343.75%
Hong Kong	HANG SENG	^HSI	EWH	5.61%	56.25%	180.95%
U.S.	S&P 500	^GSPC	SPY	3.19%	60.54%	182.84%
U.S.	Nasdaq 100	^NDX	QQQQ	0.61%	45.73%	396.04%

The main point of the table is that while U.S. markets have led the way up for much of the 1990s and the way down in the early 2000s they are not leading much in the recent past. As you can see, the U.S. indices and Hong Kong linger with single digit returns this year while average world markets are returning between 20% and 30%. Besides Brazil, there are two more countries, Japan and Mexico, with 2005 year-to-date returns of over 40%.

Why is a particular market stronger and better performing than another? What does it take? The answer is simple: volatility and correlation. Volatility just means that there need to be significant up and down moves in order to profit, assuming you know when you should buy and when you should sell. Correlation is how well the Buy and Sell signals our Model issues match the ups and downs of a given market. The more synchronized, the better the results.

How do you measure correlation? One empirical approach is to see how much the TimingCube signals enhance performance over buy and hold. When the timed results are substantially better than buy and hold it means that the timing of our Buy and Sell signals is especially accurate for this particular index, indicating a high degree of correlation. While there is a strong tendency for major world markets to generally move together, individual countries can at times fall out of correlation with the rest. A good example is Brazil as represented by the ETF EWZ, which is leading the pack this year. On the 5-year view we see a very good correlation with the TimingCube signals with an 810.16% return versus 115.89% for buy and hold. However, for the three year period started at the beginning of 2003, the timed long and short strategy returns only 134.07% versus 319.87% for buy and hold. Even the Nasdaq 100 can have periods of poor correlation, as right now, because it is by no means identical to the Nasdaq Composite index which drives our Model.

It is specifically true because we cannot predict reliably which world market will lead next, or when one will step-out of correlation that we require diversification. Instead of lamenting over the poor results in the broad U.S. indices we should take steps to limit our underperformance risk and boost our results by participating in diversified world positions.