Yesterday was one of those days in the market place where, on a global basis, everyone was worried about what everybody else was doing—or not doing. Case in point is a few headlines that I picked up on MarketWatch during the day:

“Dollar adds to gains after Ireland denies aid”

“Crude slides 3% on dollar, China worries”

“LatAm stocks slide on China, Europe worries”

With that much confusion, it’s no surprise that downward momentum reined supreme, while “dip buyers” were conspicuously absent, as they have been for the past week or so.

Commodity prices got hit hard as fears of price controls in China to limit inflation kept buyers at large. Additionally, European debt problems continued to be the center of attention as rescue packages for Ireland were being discussed, while Ireland refuses to acknowledge the need for a bailout. Reading some of these news reports is better than watching a comedy, or so it seems.

Nevertheless, the major indexes closed down, but managed a last minute rebound off the lows for the day.

Looking at the big picture, it appears that the Fed’s QE-2 plan has backfired already. Instead of lowering interest rates in general, they have been heading higher, causing bond prices, with the exception of today, to slip and slide since the announcement. I have talked about the potential of unintended consequences of quantitative easing before; this may very well be one of them.

If you’ve been reading this blog for a while, you should have your plan of exiting positions via our recommended trailing sell stops firmly in place. While none of us likes this market pullback, you need to act when market activity tells you to do so.

Yesterday, I mentioned that we had liquidated PZA. We also unloaded EVV on Tuesday, as it had triggered our sell stop. Currently, I have two positions on the sell menu for today.

I will wait to see how the market opens and watch activity for the first couple of hours. If a big rebound is in the making, I will wait another day with my planned liquidations to avoid a possible whipsaw. If there is more slippage in the market, I will pull the trigger.

Having such a plan in place, despite it not being perfect, takes the emotions out of making a decision and puts you in charge of your own destiny. At this point, the great unknown is whether this pullback is the beginning of further downside activity, or simply a correction.

I for one am not willing to wait and find out when it’s too late; I will continue to liquidate those holdings that are showing weakness. After all, moving slowly to cash, will decrease my downside risk, should we head south in a big way.

If the markets reverse suddenly and head back north, all I miss out on is some upside potential, which reminds me of my favorite saying that “I’d rather live with lost opportunity than with lost money.”

A nice rally, after last week’s set back, pushed the Dow up almost 90 points yesterday in the early going. Around mid-day, upward momentum just about disappeared caused by weakness in the technology sector along with a selloff in bonds, which pushed interest rates higher.

Actually, the 10-year Treasury note is now yielding above 2.9% for the first time since August. Contributing to the sell off was a news report by an official at Moody’s questioning the high quality of the U.S. credit rating if the Bush tax cuts would be permanently extended. This report was later “softened,” but interest rate remained elevated.

The dollar was higher against the Euro in view of the latest concerns about the open ended question as to whether Ireland is really in need of a rescue package. Crude oil slipped while gold added $3.

As an aside, last Friday, I sold all of our holdings in PZA, a national/insured Muni fund. PZA has been very steady during the past 18 months, but it suddenly headed south and moved into bear market territory. While our position was fairly small, I found the sudden detour in trend surprising.

However, I have been opposing most muni investments for several years now, since I believe that budget/debt issues and cutbacks on every level of government, along with potentially rising rates, will push those prices lower. Some of that drop in value has already occurred as 41 out of 42 muni funds that I track, are in bearish territory.

While defaults in muni bonds/funds have been very rare historically, we have also entered a period of uncertainly where everything is possible.

Until proven otherwise, I continue to stick to my viewpoint that muni funds or muni bonds are not the place to be.

In case you missed it, hat tip goes to Mish at Global Economic Trends for posting this video explaining in layman’s terms what Quantitative Easing is all about. No comment necessary:

Yesterday, I talked about how to deal with the potential of rising interest rates. What if you need to continue generating income in the face of higher rates? Losing more in principal than receiving in dividends is hardly the way to come out ahead.

MarketWatch offered some alternatives in “Bond funds that shield you from interest rate risk:”

The smart money is well aware that investing in bonds these days is risky business, especially bonds with long-term maturities, but investors are also well aware they need to allocate some portion of their assets to fixed-income securities. The question is, which ones?

“It’s a really tall order to ask someone to deliver positive returns and eliminate interest-rate risk,” Jacobson said. Rare is the time, he said, when he would have sufficient trust to give money to a manager to do anything they want. “It’s easy to make mistakes,” said Jacobson, who plans to initiate coverage of the aforementioned funds in the next few weeks.

Let’s look at performance first. Over the past 2 years JSOAX has been the clear leader; over the past 12 and 6 months periods, BND (as comparison) came out ahead, while during the most recent 3 months period (shown in chart above), JSOAX moved into the lead again.

The unknown is how quickly will fund managers change gears and go from long to short, should rates rise. I have always recommended avoiding making emotional decisions by “staying with a trend until it ends when it bends.”

This bending at the end, if in fact we have reached it, is clearly visible in the above chart, as all fund prices have recently shown downward bias, but have remained above the long-term trend line.

With a potential bond bubble brewing, the jury is still out as to whether these types of bond funds will really protect you in time if and when rates shoot up. Personally, I doubt it. These funds remind me somewhat of the much touted Long/Short funds, which never really lived up to their promise of making money in either market.

Additionally, two of the three funds featured above have front end loads of 3.75%, which I find not acceptable in an era of sliding fund/ETF expenses, especially when considering that this is an unproven product.

My preference, also in regards to bond funds, is to watch the trend and exit when my sell stops get triggered. I will then sit in cash and evaluate the investment landscape before making any new commitments.

We’re in unchartered territory with the Fed’s QE-2 and its possible unintended consequences, which makes me not very eager to seek exposure to products that have not been tried.

Disclosure: Holdings in BND

Reader Ken emailed the following question that has repeatedly come up from time to time:

I am wondering if you could foresee what the wisest investments should be for upcoming increasing in interest rates? It is obvious these low rates cannot go much lower or last much longer so there must be some place for the forward thinking investor to get a bargain.

While I agree with you that interest rates will have to rise at some point in the future, it is still an unknown as to what will trigger such a directional change. To my way of thinking, there could be two events:

1. Economic activity picks up on its own or with assistance from the Fed as QE-2 is being implemented. In its initial stages, QE-2 is designed to keep interest low to give a boost to the economy. I repeatedly have posted that I do not believe that this program will work, and it will likely end up failing and join the previous stimulus packages in a yet to be named graveyard.

If the economy makes no headway, and just muddles along (very likely in my view), that in theory should keep interest rates low for the foreseeable future.

However, there have been some rumblings that the good old U.S.A. may no longer be issuing debt that the rest of world considers worthy of being AAA rated. After all, we have indebted ourselves for generations to come.

Then we might potentially face this scenario:

2. The fact that the quality of our debt may no longer be considered AAA, yet we still have tremendous borrowing needs, means we may have to pay more via higher interest rates to continue our borrowing binge.

You think our debt is still AAA? Just on Wednesday, I posted that a Chinese rating agency reduced our credit rating to A+ from AA citing a “deteriorating intent and ability to repay debt obligations” in view of the Fed’s recent stimulus plan.

That to me that is the biggest threat to low interest rates! Due to our debt burden, our need to borrow will be ever-present, which means we may have to pay whatever the market is willing to offer. Let’s hope it does not turn out like Greece, Portugal, Spain, Ireland and/or others.

Given that, how can an investor prepare himself for the inevitable? Unfortunately, there is no clear cut answer, as we are on the back side of a busted real estate/credit bubble of epic proportions with no precedent. In other words, we are in unchartered territory.

You simply can’t anticipate not only which asset class may benefit, but you also do not know the time frame. And simply guessing is the worst you can do. Case in point is that some newsletter writers advised shorting bonds late last year anticipating higher interest rates. Well, rates plunged, and those following that advice had their heads handed to them on a silver platter.

A far better way is to follow trends in the market place. Take BND, the total bond market for example, which we have positions in. BND has come off its high but remains above its long term trend line, which means we are still in a period of low interest rates. Once the trend line is being broken to the downside, watch out; higher rates may be ahead.

To look at the big picture, make it a point to review the weekly StatSheet, especially the “ETF Master” section. It ranks all ETFs I monitor and, by looking at the %M/A column (% of a fund above or below its long term trend line), you can easily spot changes as one ETF moves below its respective trend line and another one moves above it.

To me, that is the best way I know of to determine when/if trend changes in the markets occur. If an asset class has been in negative territory and is moving above its trend line and becoming bullish, that should get your attention. If you combine these changes along with those occurring in the “Bear Market Funds section,” you will always know when momentum shifts and adjust your holdings accordingly.

I don’t have the crystal ball to guess when changes will occur, but using my free published StatSheet data will give you a heads up by keeping you informed of any important trend changes in the domestic and global market place.

My latest No Load Fund/ETF Tracker has been posted at:

http://www.successful-investment.com/newsletter-archive.php

What a difference a week makes. The bears took over, and the major indexes closed lower by about 2%.

Our Trend Tracking Index (TTI) for domestic funds/ETFs moved above its trend line (red) by +6.19% (last week +7.99%) and remains in bullish mode.



The international index has broken above its long-term trend line by +7.06% (last week +9.11%). A new Buy signal was triggered effective 9/7/10. If you decided to participate, be sure to use my recommended sell stop discipline.



[Click on charts to enlarge]

For more details, and the latest market commentary, as well as the updated No Load Fund/ETF Tracker StatSheet, please see the above link.