In regards to Sunday’s post titled “Opposing Viewpoint,” reader Tad had the following comments:

In regards to your Sunday post, I think PTTDX, or better yet HABDX, would be excellent choices when you issue sell signals for equities, especially for those who will not be aggressive enough to short, when and if that becomes the trend.

All with 7% trailing loss stops of course!

I want to hone in on Tad’s comment regarding the use of PTTDX/HABDX as a choice once a sell signal for equities has been issued. Both funds indeed held up pretty well during the 2008 massacre as you can see in this 2 year chart:

They dropped close to 10%, which is far better than many bond funds, although the total bond ETF BND showed even less volatility.

However, I want to warn against becoming complacent and expecting this same performance in the event the markets turn down again.

As I pointed out before, we may very well be at the tail end of low interest rates, which could potentially result in bond prices taking a beating as well. Recently bond guru Bill Gross of PIMCO announced their own lineup of equity ETFs, which could be interpreted as them seeing more potential in equities than in bonds. Or, they could be simply interested in gathering more assets from a different source.

Be that as it may, to guard against any other surprises, align yourself with the market trends and not news events or predictions.

Disclosure: No holdings in the funds mentioned above.

In “Bond Fund Investors Beware,” I referenced Pimco’s Bill Gross’ warning that the 30 year fixed income rally may have run its course. I talked about watching the trends for any clues of a reversal rather than relying on opinions or predictions.

Let’s use Vanguard’s Total Bond Market ETF (BND) as a guide for the general directions of the bond market. Here’s a 1-year chart:

While it is not clearly visible, the price actually broke below its 39-week long term trend line last week. While this not a guarantee that higher rates are imminent, it should be interpreted as a sign of caution.

As you can see, a trend line break occurred briefly in June 09 before the rally resumed, so you can never be sure. So far, last week’s break below the line has been less than 1%, but that could change in a hurry.

You may find this confusing as the Fed has just reiterated its current stance on continuing with a low interest rate policy for the time being.

My view is that the current pullback in bond prices (leading to higher interest rates) could simply be a reaction to the ever increasing borrowing needs. Whether you look at it globally or domestically, the debt overhang continues to be tremendous, and the need for funds to fulfill obligations is at an all-time high.

In that sense, the Fed may be powerless to control monetary policy, since demand (in this case for money) could be a stronger force able to override government policy and eventually affect the economic recovery.

Disclosure: We no longer have positions in BND

Reader Ian is trying to decide whether to swap one mutual fund for a better performing one. Here’s what he had to say:

Thanks for answering my previous questions. One of my two funds has not been in the top 100 domestic mutual funds for the last two weeks (WPVLX). Would it be counterproductive to chase momentum and move my money to one of the higher M value funds? I’m looking at BPTRX.

Just because a fund moves out of the top 100 positions does not mean it should be automatically replaced. Let’s take a look at a 1-year chart and compare both funds along with the S&P; 500:

While BPTRX indeed is currently performing somewhat better than WPVLX, it is also a lot more volatile as you can see by the drop off during January’s correction (red arrow). This becomes even more glaring when you look at a 2-year chart.

With the market having advanced as much as they did, you want to hold funds with a little less volatility to better survive any inevitable pullbacks. Given that, along with only a moderate performance difference, I don’t see justification for a swap. Additionally, both funds have outperformed the S&P; 500 for the period shown.

Assuming that you have held WPVLX for a while, you would also start all over as far as the early redemption fee period is concerned, if you were to make an exchange. Or worse, if you are dealing with assets in a trading restricted 401k account, you might trigger other restriction issues.

The key is to limit trading activity and stay with a fund that is clearly on track and let the trailing sell stop tell you when it’s time to exit and lock in your profits.

Disclosure: No positions in the above funds.

One reader continues his offensive posting battle of buy and hold being a better choice as trend tracking. Yes, there have been numerous studies supporting his viewpoint, as there have been many studies making the case for trend tracking.

He further quotes an example of 3 mutual funds that have low fees and have doubled over the past 10 years. These funds are PTTDX, BERIX and PRPFX. It was not clear whether he actually had owned these funds for the entire period or if his assessment came with the benefit of hindsight—big difference.

I plotted these funds and compared them against the S&P; 500, and they indeed outperformed the index by a wide margin, although at a quick glance it appears that only PRPFX doubled in value:

Nevertheless, if you actually had held these funds, you did better than most investors, including the majority of mutual funds, and you outperformed the S&P; 500. Congratulations!

Of course, you had to endure some severe draw downs as the last 2 bear markets wreaked havoc. And that is my point. Most investors can’t stomach seeing their portfolios drop 50% in value just as they are getting towards the end of their working years.

I have emailed with and talked to thousands of readers and investors who were financially and emotionally devastated by what happened during these past 2 bear markets. They could care less about the worn out quote that in the long term the market will always come back—by then, they may no longer be around.

Avoiding bear markets to me is crucial, but is only an alternative. If you are comfortable with hanging on to your investments, then fine. This not a battle of right or wrong, it is a matter of preference, which I elaborated in “It’s All About Personal Choice.”

Disclosure: We have holdings in PRPFX but not the other funds discussed above.

The WSJ reviewed the pros and cons of dividend ETFs in “Dividend ETFs Beckon Income-Starved Investors.” Let’s listen in:

Exchange-traded funds that focus on dividend-paying stocks trailed the market by a wide margin in 2009, but they may attract yield-starved bond investors who are also worried about the prospect of rising interest rates.

“There is no free lunch in the market, so the largest dividend yields tend to come from stocks that have fallen substantially, showing that investors do not believe the payments can be maintained,” Mr. Kay wrote in a recent report.

Whether some of these high dividends come from companies that have fallen or whether their stocks will eventually pull back sharply, does not really matter. In the aftermath of the burst credit bubble, with many long-term effects still being an unknown, the only way to guard against severe losses is to treat dividend ETFs just like you would any other investment in terms of having an exit strategy.

I discussed this necessity for bond funds, and dividend ETFs are no exception. If you are of the opinion that the bear of 2008 has been successfully conquered, then you can simply hang on to your investments. If, on the other hand, you believe like I do, that more moves in out of recessions are on the horizon over the next 10 years, then you must protect yourself against these types of cycles.

In my view, market volatility is here to stay. It’s questionable whether, after the next downturn, we’ll be so lucky to see a repeat rebound of the strength we’ve witnessed last year. Let’s not forget much of it was stimulus induced and supported by zero interest rate policy, a theme that can’t simply go on forever.

I prefer playing it safe by tracking trends and using sell stops. Why gamble and take a chance?

Disclosure: We currently have no holdings in the ETFs featured above.

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

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

Optimism that the economic recovery continues to be on track supported the major indexes.

Our Trend Tracking Index (TTI) for domestic funds/ETFs has now crossed its trend line (red) to the upside by +4.41% keeping the current buy signal intact. The effective date was June 3, 2009.



The international index has now broken above its long-term trend line by +7.20%. A Buy signal was triggered effective May 11, 2009. We are holding our positions subject to a trailing stop loss.



[Click on charts to enlarge]

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