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

Market Update

Markets sold off Monday after having scored big gains over the previous weeks. There was no obvious explanation for the drop besides the fact that stocks had become overextended and were due for a break after their multi-month rise. Markets simply cannot advance indefinitely, and pullbacks such as the one we experienced Monday are not only normal but ultimately healthy as they remove some of the complacency that has built up in the markets. The major averages regained their footing the next three days, before facing renewed selling pressure on Friday. This time, there was a clearly identified culprit: the November ISM index of manufacturing activity fell to 49.5, where economists had expected a 52.0 reading. Since a number below 50 suggests that the manufacturing sector is contracting, the ISM report raised concerns that the economy may be in for a hard landing, hitting both stocks and the dollar. The major indexes still managed to close the day well off session lows, with the S&P 500 only losing 0.28% Friday.

For the week, the Nasdaq 100 and Russell 2000 respectively lost 2.22% and 1.41%. Large-cap stocks did better, as the S&P 500 only posted a 0.30% weekly loss. All three indexes are still located above both their respective 50-day and 200-day exponential moving averages (EMAs). Our current Buy signal remains in effect.

Trend Timing School

Pullbacks and corrections

The longer a market rally goes unabated, the stronger the talk and anticipation of a pullback or correction. The same phenomenon applies to our Buy signals. The seemingly sharp drop we experienced on Monday (a relatively moderate 2.2% slide on the Nasdaq Composite) helped markets retreat from overbought territory on most technical measures, but the fact remains that the ascent since the summer lows has been mostly uninterrupted, as depicted in Chart 1. We are not saying that there has to be a pullback or correction soon, but it is only natural to expect one.

Chart 1: Nasdaq Composite's uninterrupted move



There should be no angst about pullbacks and corrections because they are not only what intersperses all bull markets but in fact, most longtime market observers insist that they are necessary and instrumental for the good health and continuation of the bull market. The primary tendency of the market is always to resume its predominant trend, which means that instead of appropriate exit points most pullbacks and corrections turn out to be good opportunities to buy for those wanting to add money, or for those sitting on the sidelines.

Before going any further we need to level the playing field by redefining what the terms pullback and correction actually mean. Widely accepted definitions for pullbacks, corrections, and bear markets can be found in Table 1 below. Anything less than 10% does not even qualify as a correction, regardless of what our nerves tell us.

Table 1: Definition of pullbacks and corrections

	% off the most recent top
Pullback	0 to 10%
Correction	10% to 20%
Bear market	20% and more

Bull markets are filled with pullbacks and, for the sake of our mental wellbeing, we should simply ignore them. For those worried about more than a pullback we can look at correction statistics. Corrections of more than 10% occur on a fairly regular basis, not on a nicely laid out schedule but at an average pace of about one per year. In the current bull market which began a little over four years ago in October 2002 we experienced four corrections, including the 14.8% drop we had between April and July of this year. While markets follow no firm rules, getting another correction soon would seem somewhat premature.

Amongst the nervous crowd there are also those who predict, for various reasons, that the end of this bull market phase is near and that a bear market is overdue. To provide more fodder to the number crunchers we observe that the current bull market, which began on October 9, 2002 for the Nasdaq Composite, at 1,514 days in duration is already the second longest of the 12 bull markets in Nasdaq history. Credit for being the longest goes to the bull market which began on October 16, 1990 and ended on July 20, 1998 (2,834 days). The average bull market duration is 816 days.

Most emotional issues in investing, such as doubt and fear, come from flawed assumptions. Market trends do not turn on a dime; if they did we would be trading all the time, not three times per year on average. In trend following, it is not uncommon for Buy trades to give back on the order of one third of the gains before a Sell signal is issued, so in the current context you should not be overly surprised to see pullbacks of 5% or more which do not trigger a Sell.

It is also important to understand that the size or percentage drop from an intermediate top does not play any role in Trend Timing or the issuance of our Buy and Sell signals (but it does for the "safety valve" 9% and 15% Cash signals. For an explanation of these Cash signals, read the "Our Service" page). In fact, we ride through the majority of pullbacks, and only a few corrections trigger a Sell signal. Since we want to participate in all meaningful market moves, our long term Trend Timing Model has us invested on the long side of the market most of the time. In order to trigger the next Sell signal our Model looks for a change in the predominant market trend, not a particular price drop. The market most clearly signals bearish trend reversals through repeated price drops on increasing volume, which are indicative of the big money, i.e. institutional investors, heading for the exits. Until this happens, we will stand firm and not worry about possible pullbacks or corrections.

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The TimingCube Staff