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

Market Update

Stocks experienced another dose of heavy volatility this week but eventually managed to close with only modest losses overall. The market was off to a bad start though, as all main indexes plunged Monday on renewed economic concerns, causing the S&P 500 to post an 8.9% daily loss. The negative tone was first set by the National Bureau of Economic Research, which said that the U.S. has been in a recession since December 2007. More bad news came from the Institute for Supply Management (ISM), as its manufacturing index dropped to 36.2 in November, its lowest level in 26 years. Fed Chairman Ben Bernanke also said Monday that he expects the economy to remain weak for some time. Barraged with such negative news, investors simply sold aggressively. Stocks managed to partly recover over the next two sessions before dropping again Thursday after several corporate giants including AT&T and DuPont announced a combined reduction of 20,000 jobs. The much awaited November employment report was released Friday morning. It turned out to be much worse than expected as 533,000 nonfarm payrolls were lost last month, the most in 34 years, where economists had only anticipated a 335,000 drop. The unemployment rate rose to 6.7%, its highest level in 15 years. Not surprisingly, stocks initially fell on the news, but the market started to recover on speculation that the dismal jobs report would force the government to supply more aid to the ailing economy. A rally in the battered financial sector also helped reversed sentiment: stocks posted solid gains in the last two hours of trading, with the Nasdaq Composite finishing the day 4.41% higher.

The Nasdaq 100 (QQQQ), S&P 500 (SPY) and Russell 2000 (IWM) respectively lost 0.62%, 2.25% and 2.55% on the week. All 3 ETFs remain located well below both their 50-day and 200-day exponential moving averages (EMAs).

For its part, our World portfolio posted a 2.60% loss this week. The portfolio consists of the 5 top-ranked world ETFs as of November 7, 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

Trend following in the face of government intervention

It is a well known fact that the government's charter includes being the steward of the economy, and that is the basis for the many forms of intervention it has at its disposal, and new ones it is creating in the current crisis. Critics have long argued that government intervention in the markets actually makes matters worse, not better. They even blame the Fed for some of the past recessions or at least for amplifying the excesses of the boom and bust cycles by sometimes doing too much or too little. The purists who have argued that the power of free markets renders useless any manipulation attempts by governments have long been discredited. There is really no debate left, if there ever was, as to whether government actions affect markets. This general topic has gathered great importance because of the unprecedented scope and magnitude government intervention has taken recently. For us investors, what really matters more than ever is how this government presence in the markets impacts our investment strategies.

One of the traditional tools for the Federal Reserve to implement its fiscal policy is the federal funds rate, which is the interest rate at which private depository institutions (mostly banks) lend balances (federal funds) at the Federal Reserve to other depository institutions, usually overnight. This is the most common form of open market operation the government uses to regulate the supply of money in the economy. It is like the gas pedal in your car. Increasing the rates (tightening) slows down the economy; decreasing rates (easing) prods it along. But prodding would be a massive understatement for what has been happening lately. The Fed started slashing the rates from a high of 5.25% in the fall of 2007 to the current 1.0%. Fed watchers now place the odds at 50/50 that the Fed will cut the funds rate another half percent (to 0.5%) at their next meeting on December 16, 2008.

It should be noted that the current hands-on approach practiced by the U.S. government is by no means new or exclusive to this country. Just this week, as fears of a deepening recession grew, central banks have been quite busy with the ECB (European Central Bank) slashing its interest rates from 3.25% to 2.5% - the most aggressive cut in its 10 year history. On the same day, the Bank of England also cut its rates from 3% to 2% while Sweden's Riksbank cut theirs from 3.75% to 2% as well (a new record breaking cut). Japan has kept its interest rates near 0% for years.

But interest rate cuts have largely outlived their usefulness as they approach 0% and the economy has not regained its footing yet. This is why other drastic measures have been called upon to flood the economy with liquidity. There seems to be an endless flow of new government programs and facilities aimed at keeping the economy from falling over the proverbial cliff. The Fed and Treasury Department have been pulling all the stops. It started with loans or loan guarantees, then evolved to bank bailouts in which the government purchases bad debt (the mostly worthless mortgage derivatives no-one else wants), and has now escalated to outright investments in the stock of troubled banks.

Some economist used to be outraged by the sums the government throws around to manage the dollar exchange rate through the Exchange Stabilization Fund (as of October 31, 2008 the fund had total assets of nearly $48 billion - see the monthly statement here for details). Well, according to various estimates, the federal bailouts, equity buys into banks and investment houses, loan guarantees, tax breaks, economic stimulus checks and other liquidity infusions by the Federal Reserve Bank and Treasury so far this year now total $8.5 trillion! To put $8.5 trillion in perspective, that is nearly 60% of the nation's gross domestic product (GDP). Chart 1 below provides another way to get a feel for how gigantic the number is. It compares the current $8.5 trillion to other major expenditures in U.S. history.

Chart 1: Major expenditures in U.S. government history


Source: Bianco Research and Joseph Stiglitz

Even the entire cost to the U.S. of World War II, in inflation adjusted dollars, is dwarfed by the current situation. On the bright side, only about $3.2 trillion of the $8.5 has been tapped so far, according to Bloomberg. For all we know, the rest may never be used, and optimists are pointing to the potential gains these government "investments" could yield down the road.

On the other hand we have heard the desperate pleas for help from the auto makers. Even more worrisome are the options being discussed to curb the number of foreclosures. Some proposals would have the government purchase delinquent or at-risk mortgages in bulk and then refinance them through another government program that insures home mortgages.

With most major world economies now officially in recessions, energy and commodity costs sliding faster and further than anticipated and a raft of economic news suggesting a sharply deteriorating economic environment, many are warning that deflation (falling prices) is now a bigger risk for the coming months than inflation. This is no doubt coming as welcome news to all the governments who can continue their massive liquidity injections without having to worry too much about causing inflation in the process. We know that in time such massive interventions will have dire consequences, such as a devalued dollar, ballooning debt and deficits, but for now our financial leaders are convinced this is the right prescription to save the economy from falling into a deep depression.

We believe that most forms of fundamental investing, where one attempts to assess the real value of a company or market to make investment decisions, are placed in serious jeopardy by the current stimulation efforts. This is especially true for investments in individual companies or sectors most directly affected by the government's market operations, but the market as whole is impacted as well. The most obvious example is what happened recently to financial institutions implicated in the bailout such as Fannie Mae, Freddie Mac, AIG, and Citibank to mention a few. Citibank's stock more than doubled in price in the days following the announced bailout. An investment in the big three automakers at this juncture would be another almost pure bet on the eventuality of a government bailout.

Technical investing is not immune either, especially when applied to shorter term trading or when based heavily on overbought/oversold indicators which tend to become highly unreliable in the face of extraordinary events. And an $8.5 trillion liquidity drop certainly qualifies as extraordinary. For our part, instead of predicting what the market should do next and what price it should be at, we specialize on watching what the market actually does. Our brand of trend following detects the major directional changes in the forces which underlie the market. There are many elements which influence the markets. Any factor strong enough to move the market is detected because of that very movement, be it the government or something else. We do not have to guess as to when and how much of an influence the economic stimulations will have, we simply wait for the market to establish a new trend.

FAQ of the Week

Question: Does volume play a role in the World ETF Ranking?

No. Unlike our trend following model which takes volume into consideration in order to issue Buy/Cash/Sell signals, the World ETF Ranking does not. Instead of looking for changes in the primary market trend the World system focuses exclusively on price momentum, as expressed by our proprietary Strength indicator, to rank various geographic markets relative to each other. The strongest can have negative momentum, as they currently all have, but their rankings are not based on how much they are traded.

Warm wishes and until next week.

The TimingCube Staff