TimingCube - ETF versus Index - Producer Price Index, PPI, price inflation, ETF tracking errors, Consumer Price Index CPI

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Shortened Holiday week ahead!

With the markets closed this coming Thursday and closing early on Friday for the Thanksgiving Holiday, our Weekly Update will be on hiatus as well, for its first break ever (well deserved we might add ). The "Current Signal" page will be updated after the market close on Friday November 25, 2005 and the Weekly Update will resume its regular schedule on Friday December 2, 2005.

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, despite modest gains, the market made a strong bullish statement. Monday's listless session was followed by a broad decline on higher volume. This distribution day occurred in the face of oil retreating below $57 for the first time in months. The catalyst for the retreat was the Labor Department's Producer Price Index (PPI) figures for October, which jumped 0.7% when economists expected it to remain flat. The PPI, which measures wholesale prices, is an indicator of future price inflation at the consumer level, something the stock market never likes to see. These inflationary fears quickly waned with the announcement on Wednesday of a reassuring Consumer Price Index (CPI) reading which rose only 0.2% in October.

The turning point of the week occurred on Thursday with a broad-based rally on higher volume which not only erased earlier losses but propelled some markets to new highs. The Nasdaq Composite index exceeded its August high and closed above 2220, a level not seen in 4-1/2 years. The index has now gained for five straight weeks. The Dow Transports even closed at an all-time high, as did the S&P Mid-Cap 400 index. It is significant that 2220, once penetrated to the upside, instantly became support and resisted on at least three occasions today, Friday. Still, by remaining close to this important line the Nasdaq is still vulnerable, but the longer it resists above this level, the stronger the rally will be.

For the week, the Nasdaq 100 benchmark was ahead by 1.60%, the S&P 500 gained 1.02%, and the Russell 2000 trailed with 0.83%. With the week's strong bullish action, our signal remains a Buy.

Trend Timing School

ETF versus Index

We generally report and track performance using market indices, because they are industry standards and data is broadly available, instead of reporting on the numerous choices of investment vehicles that track them. Our primary focus having been the Nasdaq 100, Russell 2000 and S&P 500, and their Exchange Traded Funds (ETF) impersonations - QQQQ, IWM and SPY - providing us very accurate proxies, we generally assume our returns will closely match those of the index. Last week's Trend Timing School article "Changing of leadership" which compared the returns of various international stock market indices provides us a good test-case to verify this assumption.

When comparing the returns of the ETFs with their comparable indices shown in Table 1 below, it becomes apparent that results vary considerably. The deviation between U.S. ETFs and indices is contained within a small 10% to 20% range. The big surprise comes with the international ETFs which stray from their indices quite substantially, both for the better and the worse.

Looking at the 1-year gainers - for which the ETF does better than the index - we have Canada and Australia. In last week's table we saw that the Canadian S&P/TSX index was up a good 27.77% in one-year but the corresponding country ETF would be up 38.79%, 39.68% better. Similarly, the Australian ETF would have beaten its index by 20.38%. On the downside, an investor in the UK ETF would have made 36.45% less than its index (16.53% versus 26.01%), and the Japan ETF EWJ trailed its index by 28.54% (a more than respectable 32.57% return versus 45.58% for the index).

Table 1: Returns of ETFs compared to indices
(when traded according to the TimingCube signal and a "Long and Short" strategy. 11/11/2005 data for comparison with last week's article)

		ETF return versus comparable index			Comparable indices
Country	ETFs	1-year Return	3-year Return	5-year Return	Index Name	Yahoo! Finance Symbol
Canada	EWC	39.68%	-9.76%	2.04%	S&P/TSX	^GSPTSE
Australia	EWA	20.38%	38.74%	49.05%	All Ordinaries	^AORD
U.S.	SPY	18.81%	-12.24%	-8.18%	S&P 500	^GSPC
Brazil	EWZ	-1.62%	-30.52%	-4.91%	Bovestpa	^BVSP
U.S.	IWM	-2.15%	-8.32%	-9.95%	Russell 2000	^RUT
France	EWQ	-3.83%	0.98%	0.52%	CAC40	^FCHI
Mexico	EWW	-5.18%	4.31%	10.67%	IPC	^MXX
Germany	EWG	-23.88%	-22.86%	-18.17%	DAX	^GDAXI
Japan	EWJ	-28.54%	-12.19%	-31.80%	NIKKEI 225	^N225
U.K.	EWU	-36.45%	-0.69%	-27.31%	FTSE 100	^FTSE
Hong Kong	EWH	*	1.21%	1.09%	HANG SENG	^HSI
U.S.	QQQQ	*	-3.58%	0.31%	Nasdaq 100	^NDX
* Ratios of small numbers are meaningless

Admittedly this data is highly theoretical because there is no way to invest in an index and no practical means to short most of the international funds, EWJ being one of the few with options available.

So what are the reasons for such large ETF tracking errors?

Currency exchange rate. This is probably the single biggest component of the differences for international funds
Index matching. Some use different indices or make up their own. A good example is the many iShares country ETFs which track MSCI indices which are not the same as the public country stock exchange indices and for which no historical data is publicly available
Sampling. Some funds simply sample from the universe of stocks constituting the index, instead of a full replication
Differing dividend reinvesting policies
SEC- and IRS-mandated diversification requirements. The regulation that stipulates that no single company may account for more than 25% of the fund's total assets
Fees and expenses

The bottom line for us Trend Timers is that, regardless of how much more or less the indices would have returned, diversifying in the country ETFs that have the strongest wind in their sails can be a very rewarding proposition. The ones with the best 1-year returns are EWZ (Brazil) with a 57.58% gain, EWW (Mexico) 41.39%, and EWC (Canada) at 38.79%.

FAQ of the Week

Question: Will the discontinuation of M3 data impact your Model?

A number of astute subscribers noticed the recent announcement by the Federal Reserve Board that they will cease the publication of the M3 monetary aggregate on March 23, 2006. Beyond the fancy name, M3 is simply the broad measure of the money supply in the United States. M3 reflects how much liquidity the FED is injecting into the system, and its growth rate is widely used as an indicator of future currency inflation. Many have questioned the motives and the timing of making the FED more secretive about something as important as our money printing presses.

Regardless, M3 plays no role in our Model and therefore will not be missed.

Warm wishes and until next week.

The TimingCube Staff