Hardly a day goes by without some piece of data being released, which casts doubt on the economic recovery. Yesterday, the culprit turned out to be a large drop in consumer confidence, although better-than-expected earnings from Walgreen offset the bad news helping the market close higher.

The rally gathered some steam in the last hour of trading as the dollar declined against the yen and the euro.

Causing trouble early on was the Consumer Confidence Index, which slipped to a reading of 48.5 in September from a revised 53.2 in August. That turned out to be the lowest level since February.

It’s no surprise that confidence is waning in the face of no improvement in the labor markets and continued uncertainty whether a double-dip recession can be avoided. For that matter, it’s questionable whether the economy can even stand on its own legs and produce growth without being stimulated.

All that uncertainty helped gold break through the $1,300 level with silver reaching its highest price since 1980.

New data will be closely watched as we head into the final quarter of 2010. At the first sign of more economic weakening, the Fed has promised an assist via Quantitative Easing 2.0; an effort which will be closely scrutinized to see if it can produce any meaningful results.

In the absence of any positive effects, traders on Wall Street may very well reevaluate if these lofty market levels are indeed justified.

Chart courtesy of MarketWatch.com

The bulls tried to keep upward momentum going yesterday, but other than a quick peek above the unchanged line, the major indexes meandered in negative territory and closed to the downside.

Profit taking contributed to the sagging of financial stocks in the last hour. Activity was confined within a small trading range, which is not surprising after Friday’s strong breakout above the S&P;’s resistance level.

Europe contributed to the weakness in financials as Moody’s downgraded the rating of Anglo Irish Bank to one level above junk. Also, concerns mounted that banks with sizable brokerage departments might see fewer earnings because of reduced trading volume over the past four months or so.

Bonds rallied, as interest rates were lower with the Treasury selling two-year notes at a record low yield of 0.441%.

If you think that’s a sign of deflation, you are correct, despite of what some of the inflationary worry birds would have you believe. Sure, eventually inflation will be an issue to be reckoned with; however, right nowhere it’s nowhere in sight, despite’s the continued Fed’s attempts to create it.

Chart courtesy of MarketWatch.com

Bill Fleckenstein presented these interesting economic thoughts a few days ago in “Cuba understands what US doesn’t:”

As even the Cuban government lays off workers, we can’t seem to face the looming problems posed by our own bloated public payrolls.

Neither can the United States. And if a communist government like Cuba can admit it and make changes, why can’t we?

Yes indeed, why can’t we? The goal of any government in my view should be to run a country with the greatest amount of effectiveness and efficiency and at a minimum cost to the public.

While very likely politicians on both sides of the aisle would agree with that assessment, it is far easier and politically safer to stay with the status quo and not rock the boat. In other words, it’s business as usual.

Hat tip goes to reader David for providing the above chart, which was created by Pension Partners.

There are a few interesting observations about this data set:

• The 10 best days account for 50% of the buy and hold performance (roughly 0.2% of the days from 1993 to August 2010).

• Classic “Buy & Hold” nets $324,330.15

• Missing the 10 Best Days gives up more than 50% of the Buy & Hold performance: $156,354.12

• If you manage to avoid the 10 Worst Days, your portfolio more than doubles the Buy & Hold performance: $692,693.90

The lesson I take from this: It is great if you can avoid the major down days, but only if you can do so in a way that does not have you missing the major up days. If you manage to avoid all of the Worst days, but miss all of the Best days too, then your portfolio performance will be is nearly the same as straight Buy & Hold (but with additional taxes and commissions paid).

Now the reality is no one will consistently miss all the worst days — I’m the first guy to admit our 100% Cash call the day before the flash crash was dumb luck — but you can avoid being long for most of a secular bear market. If you can miss the longer downtrends, you end up way ahead. Not drops that last days or weeks, but the secular months and quarters in the red.

That might be more challenging approach to chart — but it’s worth exploring . . .

It has always been my belief that avoiding the downside is far more important for long-term portfolio performance than to participate in every uptick the market throws at you.

The above chart makes a good point in demonstrating that, unfortunately, only on a buy and hold basis. It would be interesting to see what the effect would be when used with the rules of trend tracking, where you automatically avoid the worst days in the market.

At the same time, however, some of the best days in terms of rebound rallies may very well happen while in bear market territory; so you would miss those as well.

Since it is impossible to foresee when the best days or the worst days are about to happen, this analysis is pretty useless as an investment method. Trend Tracking on the other hand offers a viable alternative.

Let’s look at our last domestic sell signal effective 6/23/08. The S&P; 500 stood at 1,318 and closed last Friday at 1,149. That means it still has to gain another 14.74% just to reach the breakeven point despite the sharp rallies off the March 09 lows.

I am sure that during the period we were out of the market (6/23/08 to 6/3/09) we saw some of the worst days and some of the very best ones. The key, however, was to be out altogether to avoid the market meltdown, which makes it unimportant as to whether we participated in the best recovery days or not.

Occasionally, I have posted about a no load mutual fund that should belong in every investor’s portfolio, even if your general preferences are the use of ETFs.

The WSJ reports in “Permanent Portfolio (PRPFX): How a Forgotten Fund got Hot in a Hurry:”

I’ve been following the ‘permanent portfolio’ theory on and off with one eye for a few years, and it’s actually been quite an interesting performer. Especially the past few years with the 2nd massive bear market in a decade in equities, combined with a multi decade bull in bonds (only accelerating of late), and the decade long surge in gold. It is championed by Harry Browne – a quick overview.

The Wall Street journal has a story on this tortoise that beat the hares. A quite amazing story – in August of this year the fund received more inflows than it did in its first 25 years combined!

There is more information contained in the above link, so be sure to click through if this fund is of interest to you.

We have had holdings in PRPFX for quite some time and, during the past buy cycle (since 6/3/09), it was the only fund/ETF that never reacted poorly to market pullbacks and consequently never caused a whip-saw signal.

This fund lends itself perfectly to trend tracking but the name is a bit of a misnomer. While indeed it held up better than most during the 2008 massacre, you would have been better off selling it as per our trend tracking exit strategy. Nevertheless, it comes as close as I have ever found a fund to be “permanent.”

Prior to the above story, I had just finished by own back testing to see how PRPFX might have performed during the “lost decade” (12/31/1999 to 12/31/2009), during which the S&P; 500 and just about any other fund showed negative returns.

Here is the testing methodology I used:

1. Buy PRPFX on 12/31/1999
2. Hold it until the 7% trailing sell stop takes you out of the market
3. Re-invest as soon as the price has risen again by 3% above the price you were stopped out of
4. If you get stopped out again, use the same reinvestment process

Using this simplified approach, PRPFX would have gained (including dividends) +125.18% for the “lost” decade. As comparison, the S&P; 500 (as represented by SPY lost 10.32% (including dividends).

Here’s the important part. Because of PRPFX’s lack of volatility, you only would have been stopped out “four times” in 10 years. While this does not represent true trend tracking, it nevertheless demonstrates that the tortoise can beat the hare.

I tested a variation of the above by allocating 50% to PRPFX and 50% to a bond fund (VBMFX) and applied the same principles over the same period. This combination returned a total of +93.88%. While PRPFX again had 4 buy/sell signals, the bond fund had none.

Again, this is merely meant to be a demonstration and not any guarantee that similar performances can be repeated in the future. However, it clearly shows that you don’t have to be in the hottest fund or latest ETF to outperform the S&P; 500 or just about any other fund.

The key to this success was clearly the fact the major downturns were avoided, which to my way of thinking is the number one portfolio wrecking ball. Moderate upside along with bear market avoidance will give you better odds at long-term success.

I will continue with my back testing efforts using all past trend tracking buy/sell cycles and will share the results with you once I have them.

Disclosure: Holdings in above funds

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

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

It was a roller coaster ride with Friday’s strong up day more than making up for the mid-week losses.

Our Trend Tracking Index (TTI) for domestic funds/ETFs held above its trend line (red) by +5.27% (last week +3.74%) and remains in bullish mode.



The international index broke back above its long-term trend line by +5.57% (last week +4.21%). A new Buy signal was triggered effective 9/7/10. If you decided to participate, be sure to use my recommended sell stop discipline.