One reader is concerned about the effects of a correction on his portfolio. This was his recent comment:

If the markets, both domestic and international should have a considerable correction, any thoughts on what asset class might have the largest drawdown? Generally, I think it’s those up the most. At this time it would seem to be emerging markets, Nasdaq tech and small cap).

The obvious leaders on the way down will be all leveraged funds, such as the ProFunds Ultra series and yes, those that have gained the most.

From my vantage point, those ETFs with the greatest DrawDown (DD) during the fairly minor corrections since the low of March 9, 2009, will be the ones to watch.

In regards to Country ETFs, here are the top five with the Max DD% (not shown in the StatSheet) in parentheses:

Russia (RSX: -30.21%), India (IIF: -27.03%), Emerging Europe (GUR: -24.25%), Turkish Investment Fund (TKF: -18.86%) and Asia Index (ADRA: -18.25%).

Looking at sectors, here are the top five from that arena:

Natural Gas Fund (UNG: -52.59%), Internet Infrastructure (IIH: -30.61%), Regional Banking (KRE: -26.50%), Homebuilders (XHB: -24.10%) and Metals & Mining (XME: -23.56).

Of course, some of these (not UNG) also have moved up the most, so if you work with my recommended 10% trailing sell stop in these areas, you should be able to lock in most of the gains once the downside comes into play.

Along these lines, some readers have emailed and asked if it would be wise to take profits now or at least reduce exposure. To me, that would be making an emotional decision based on what might or might not happen. The purpose of trend tracking is to stay in the market until the trend comes to and end and starts to reverse.

That’s when your trailing sell stops will indicate that’s it’s time to step aside and move to the sidelines—and not before.

I am not a believer in conspiracy theories, but occasionally I have voiced my opinion during the past 9 months questioning the fundamentals driving this market rebound. While fundamentals do not influence my decision making process in regards to trend tracking, I do try to evaluate the economic landscape.

Predominantly questionable economic news reports have made me wonder where all this market support is coming from. Friday was one example when a horrific jobs reports report, at least compared to expectations, left the markets unscathed with the major indexes closing higher.

It’s a well known fact that the Fed has manipulated interest rates in order to support and speed up an economic recovery. I have sometimes wondered whether the Fed has given a helping hand and supported the stock market as well by pumping in a few trillion dollars.

Of course, I can’t be sure, but I consider it a possibility. Hat tip goes to Random Roger, who featured a couple links on this topic. One is titled “TrimTabs on that US government rigged stock market:”

TrimTabs Investment Research Asks Whether Federal Reserve and U.S. Government Rigged Stock Market, Pushing Market Cap up $6+Trillion since Mid-March

In a Financial Times article in 2002, an unidentified Fed official was quoted as acknowledging that policymakers had considered buying U.S. equities directly, not just futures. The official mentioned that the Fed could “theoretically buy anything to pump money into the system.” In an article in the Daily Telegraph in 2006, former Clinton administration official George Stephanopoulos mentioned the existence of “an informal agreement among the major banks to come in and start to buy stock if there appears to be a problem.”

There are many more details available, so if this topic interests you, follow the above link.

Again, I can’t be sure whether any of this played out along these lines, but by just having watched market behavior, I have had similar thoughts.

I am sharing this with you to point out that this remote possibility exists and to make sure you do not become complacent during this rally. Sooner or later the trend will come to an end, maybe abruptly, so be sure to know where your sell stops should be, and be prepared to act when market behavior tells you to do so.

In case you missed it, Reader Paul posted a comment last week that he was a little discouraged with his investment results. He had this to say:

Your post “Absolute Returns” really helped me emotionally. Yesterday, I was a little disappointed when I compared my 2009 returns to my benchmark returns. After reading your post today, I decided to combine my 2008 and 2009 returns. I discovered that I am much better off by using a trend following strategy!

Still following the trends…

This brings up an important issue. Once you decide to use an investment discipline, such as trend tracking, you need to be aware of its strengths and weaknesses by looking at the big picture when evaluating its results.

It’s an unfortunate fact that investors have very short memories and seem to live by the mantra “what have you done for me lately?” Of course, the media supports this type of thinking, which is why the focus of investment returns has been the rebound of 2009 while the effect of the market disaster of 2008 (or the decade for this matter) has been shoved on the back burner.

To evaluate your returns, you need to combine the good with the bad as Paul has done and not just focus on one exceptionally positive or negative period. That is what I mean by keeping the big picture in mind.

There are some investors who got caught in between. They decided to switch gears late in 2008, after the market drop, and adopted trend tracking. Obviously, their main motive was to make up losses, which may not have worked out to their satisfaction.

The reason is that, once a severe market drop occurs, Trend Tracking lags before it gets us back in the market as we’ve see last year. Our domestic TTI not signal a buy until 6/3/09. While it simply takes time for long-term trends to re-establish themselves, I realize that it did not help those with the urge to quickly regain what was lost in 2008.

Everyone else, who got out in June of 2008, had no problem patiently waiting until a new buy was generated. If you are in the camp that would have liked to have done better in 2009, combine your returns of 2008 and 2009 and you may find, as reader Paul did, that you are ahead in the game compared to simply having held on through the past two roller coaster years.

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

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

After a strong start, which set tone for the week, the major indexes maintained their upward momentum and closed higher.

Our Trend Tracking Index (TTI) for domestic funds/ETFs has now crossed its trend line (red) to the upside by +6.45% 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 +10.64%. A Buy signal was triggered effective May 11, 2009. We are holding our positions subject to a trailing stop loss.

As is the case at the beginning of each year, the Momentum Index shown in my weekly StatSheet is being reset.

Since it consists of an average of the 4wk, 8wk, 12wk and YTD momentum numbers, the YTD figure is obviously lower at the beginning of each year contributing to a reduced overall M-Index number.

Keep in mind that the ranking number by itself is meaningless; it only has value when compared to other funds/ETFs. This change will be effective with the next StatSheet dated 1/7/10, which will be mailed in this Friday’s weekly update.

After Monday’s sharp rally, a pullback would have been in order yesterday but, as we’ve seen so many times in the past 6 months, a mid-day sell-off was rebuffed by last hour buying.

It was a tug-of-war between 2 news items, as the indexes initially were dragged down by a report that pending home sales fell 16% in November, far worse than the expected 2% decline.

Offsetting this piece of bad news were encouraging auto sales and a report that factory orders had risen more in November than analysts had anticipated.

All in all, it turned out not to be not a bad day given the previous run up. We are holding all positions subject to our sell stops, and I am making some portfolio adjustments to stay aligned with market direction.