Towards Bear Market Territory?

Yesterday’s sudden market reversal to the downside pushed our domestic indicator Trend Tracking Index (TTI) further towards bear market territory. The domestic TTI is now positioned only +2.32% above its long-term trend line, while the international TTI has slipped even further south to -6.91%. This again confirms our Sell signal in that area, which was effective as of 11/13/07.

It seems like weakness is spreading to a variety of sectors where current trends may come to an end as well. Such was the case with PBW, which hit our pre-set 10% sell stop point and was sold early yesterday morning prior to the markets washing out.

A couple of other sector holdings are within striking distance, and we will execute the sell stops as necessary. With the Dow just having had its worst first five trading days of the year ever, it behooves to pay attention to some words of wisdom. MarketWatch featured a story by Bill Donoghue titled “Into the woods.” Here are a few snippets:

Perhaps the three worst things that can happen to your portfolio now are: Buying stocks hitting new records (that’s behind us); selling too late, and passively failing to protect your assets.
Fortunately, you have some time to react. First, ignore advice to “stay the course,” and observations that “index funds are cheap and bond funds are safe.” That’s useless in a bear market. Index funds and balanced “lifecycle” funds lose when their benchmarks decline and bond funds lose when interest rates rise.

That’s been my experience as well. Especially, don’t fall for the “cheap” index fund story. That approach may work fine in a bullish environment but will be devastating should we slide further towards a bear market scenario.

“Big Ben” Bernanke’s time may be up. The Fed is not helping matters much. Interest rate cuts may slow the stock market’s decline, but it undercuts the value of the U.S. dollar. As the dollar erodes, foreign investors, mostly from the Middle East and Asia, use their stronger currencies to buy into Wall Street firms at fire-sale prices.

The regulators dropped the financial ball. The ratings agencies, real estate appraisers, mortgage bankers, realtors and the lenders all have conflicts of interest. Banks, thrifts, insurance companies and other financial institutions are continuing to write-off subprime debt. Don’t buy their sales pitches.

Remember, everyone has some bias. There will be times that we will pass through a transitional phase where cash in money market is a great option. Don’t be in a hurry to throw your money at some hot fad ETF. Follow the trends to make your decisions.

What can you do? Invest in exchange-traded funds or mutual-funds that are geared to profit from market and sector declines. These so-called inverse funds, or related bear-market funds, are available from ProFunds and ProShares, Rydex Investments and Direxion funds.

While our domestic TTI has not given the signal to stand aside yet (or get into bear market funds), there are already opportunities in selected short ETFs. Short commercial real estate and financials have done very well. Be aware that many carry the description “ultra,” which means that performance is twice of the underlying index. That can produce nice profits, if you’re right and timely, but can also accelerate losses.

For example, we have a few aggressive portfolios containing SRS, but with only a 5% allocation due to the high volatility. How much volatility? For the 10 days we’ve been holding this ETF, it’s up 19%—so be careful with aggressive ETFs and, most importantly, never ever work without a sell stop.