Yesterday turned into one of those classic “buy the rumor, sell the fact” situations as the Fed’s unchanged stance on interest rates failed to inspire the buyers.

Actually, the bears took over, and the major indexes headed straight south, although the losses were moderate given the size of the rally since the March 09 lows.

The initial reaction after the Fed announcement was positive, as the chart shows, but disappointment over lack of bullishness in the language disappointed traders and off the highs we went.

Our Trend Tracking Indexes (TTIs) retreated slightly but remain firmly in bullish territory:

Domestic TTI: +8.30%
International TTI: +16.82%
Hedge TTI: +3.32%

We will now have to see if the pattern of the past few months repeats itself, meaning that the moment the indexes give back about 1%, buying sets in, and we’re on our way to higher highs.

Sooner or later this trend will come to an end and reverse. Be prepared by having your trailing sell stops in place so that you can exit at a moments notice, should market behavior dictate such action.

Reader John had this comment regarding my review of PRPFX last Saturday of:

That said I have not always been this enthusiastic about it (PRPFX). The fund’s expense ratios were unacceptably high for a long time and have only recently dropped into a range I am prepared to support. (I refuse to buy mutual funds with expenses greater than 1%. There are very, very few that are worth it and for those that are, one can generally find cheaper alternatives.) You can build your own Permanent Portfolio with funds that are generally less expensive, although this is more labor intensive as you have to do all of the frequent rebalancing yourself.

One part of John’s comment reminds me of what I have heard from many investors over the past 20 years in that they look at mutual fund/ETF expense ratios as the most important factor in selecting an investment.

This seems to be some leftover attitude from the buy and hold type of investing. Granted, if you hold any fund for years without ever sidestepping any bear market, reducing the cost of that investment makes a lot of sense.

However, when you are in trend tracking mode, upward momentum followed by performance is the most important ingredient for success. After all, who cares what the charges are if the rewards far outweigh the expense.

Case in point is what happened after the 2000 bear market. We re-entered in 2003, and one of my fund selections was the Nicholas Applegate fund. It absolutely exploded by gaining over 60% in 3 months. If I had looked at the expense ratio first, I probably would have not selected this fund.

The lesson learned is that’s it’s not worth trying to save nickels and waste dollars in the process.

Reader MD was interested in mutual funds that automatically protect any profits made. He had this to say:

I am interested in No Load mutual funds, which use hedging strategies like shorting or buying options to protect the gains realized.

Don’t I wish that these types of funds exist. While all mutual funds turn over their holdings several times a year, they will not accomplish what you have in mind.

The only types of funds that attempt to make money in both bull and bear markets are long/short funds. I track some of them in my data base, but do not publish the results, since they have been less than impressive as far as long-term performance is concerned.

Year-to-date, they have been doing fairly well as you can see from the following table:



I have found that these funds tend to perform better during bullish periods than during bearish ones.

Take a look at this 5-year chart comparing SWHEX compared to the S&P; 500 (the green line represents the 200-day M/A):



As you can see, during this period SWHEX tracked the S&P; 500 fairly well, but still went down sharply as the bear struck with full force last year. The drop was considerably less than for the S&P; 500, but did not offer the type of protection that you might have expected.

You still would have been better off stepping aside via trend tracking in 2008 than taking a chance with a long/short fund. I hate to tell this, but a fund that automatically gives you the best of both worlds (locking in gains in bull and bear markets) simply does not exist.

You have to add your own exit strategy to any of your holdings to make sure you are protecting your portfolio from too much downside risk.

Last week’s discussion about sell stops, whip-saws and distributions generated a lot of reader feedback. As I said, most of these issues have been covered before, but they are important and worth repeating so that new readers get the benefit as well.

Reader MD had this to say:

A ‘Sell stop’ is an excellent vehicle to hedge your portfolio of equities. But, what about ‘Mutual funds’? How can we use a strategy like ‘Sell stops’ with mutual funds??

Remember what I said about ETFs? My sell stops are based on “day-ending prices” only, so what happens during the day is immaterial to me. One reader called the intra-day market activity casino mentality, and I have to agree to some extent.

I treat sell stops for mutual funds and ETFs exactly the same. If a sell stop has been triggered for either, based on the day’s closing price, only then I will enter the order to sell the next day.

I never ever enter stops beforehand to avoid getting stopped out during intra-day market swings.

I realize that waiting with your sell order until the next morning might interfere with your work schedule, but the markets are open for many hours. With online trading even being available on your cell phone, you should be able to find a few minutes to place your trades.

Hat tip goes to Mish at Global Economic Trends for pointing to a link featuring an interview with the author of the well known book “The Black Swan” Nassim Taleb.

I reviewed his books sometime last year and being a being a very straight thinker, he had some interesting thoughts in a recent interview on the current state of the economy.

Here are some highlights:

Margaret Wente: Happy days are here again. The central bankers say the recession is over. The markets are buoyant. Can we relax?

NT: My whole idea is to lower risk in society by developing a system that can resist human error, rather than one where human error rules. The first step is to make sure that no financial institution is too big to fail. Next, make sure governments don’t favor big companies. Governments should also decrease the role of economists – they’re no more reliable than astrologers, and they do more damage.

Nassim has been warning about unpredictable events for a decade and has foreseen the credit crunch. I happen to agree with his assessment, although he is far more qualified to talk about these issues than I am.

We will continue to have to live with great uncertainty. While we have no control or influence over what governments can and will do, we at least can improve our odds of not going down should the markets finally recognize that this recent rally was based on nothing but smoke and mirrors.

Having an exit strategy for “all of your positions” will ensure that any losses will be minimized so that your portfolio can be safely on the sidelines, should a “Black Swan” event occur.

I must admit that reader feedback is an important component in supporting my efforts of generating blog posts on a daily basis.

Sometimes, comments can be pretty funny, yet have serious undertones. This was the case when reader Robert questioned the U.S. dollar as a reserve currency, and he had this to add:

I’m not buying gold, can’t afford it. The bargains at Wally World will no longer be cheap for those of us on Social Security. What can a poor slob do?

Even with a limited portfolio, you can participate by having exposure to gold, silver and currencies, among other investments, by selecting one no-load fund that covers most of these areas.

While many investors try to diversify into gold and a variety of currencies in the hope of catching some of the gains as the dollar loses its value, some of these sector ETFs are highly volatile and can subject you to roller coaster rides.

I have discussed this area a year or so ago, but with many new readers, it’s worth repeating. Take a look at PRPFX, with the somewhat misleading name “Permanent Portfolio.” In the world of trend tracking, there is nothing permanent, no matter how solid an ETF/mutual fund appears.

Case in point is PRPFX, which shows a steady upward climb until last year’s crash. Take a look at this 5-year chart:

It’s obvious that buying and holding would have wiped out several years of gains, while trend tracking would have preserved your capital. What does PRPFX consist of?

Here’s the definition as found on Yahoo Finance:

The investment seeks to preserve and increase the purchasing power value of its shares over the long term. The fund invests a fixed target percentage of net assets in the following investment categories: gold, silver, Swiss franc assets such as Swiss franc denominated deposits and bonds of the federal government of Switzerland, stocks of U.S. and foreign real estate and natural resource companies, aggressive growth stocks and dollar assets such as U.S. Treasury securities and short-term corporate bonds.

There you have it. It would appear to be a fund to own in uncertain times. It is diversified, and all you have to do is follow its trend and apply my recommended sell stop discipline.

Again, as much promise as this fund has, emotionally, as trend trackers we do not fall in love with it nor do we get married to it. We merely date it until it no longer serves our purpose, and then we move on. It may seem cold and harsh, but so is the world of investing. If you don’t look out for yourself, nobody else will.

Disclosure: We currently have holdings in the fund discussed above.