Lately, I have been receiving a lot of subscriber email wondering what to do with their invested positions. I personally find it hard to believe how some people subscribe to my free newsletter, which spells out exactly when to buy and sell, and then proceed to do the exact opposite.

Even my constant nagging of using sell stops seems to simply fall on deaf ears.

Consider the latest email from an anonymous reader:

My entire portfolio is invested in the following mutual funds……….would you continue to hold or bail out…….I have emerging Markets……..gold …..energy ……natural resources……..oil and gas…energy services…..oil and gas services, and precious metals and precious minerals………. ………….China ……..India………that is 10 areas. I think that covers it…………..I am getting clobbered ……but I know and feel that these are all areas that are going to rebound…….as soon as the i***t is out of office………

Of course, you are getting clobbered when you’re hanging on to investments that are in severe downtrends. None of these should be held during a bear market. Take a look at a chart:




Had you used my recommended sell stop discipline for sectors and country funds of 10% from the high since you bought them, you’d be 100% in cash right now. You’re playing the game without a plan, based on your wild hope that a new president in office will make all the difference and that your holdings are going to rebound.

While that possibility exists, it’s not a basis for making intelligent investment decisions. This is the exact type of wishful thinking that has killed portfolios during the last bear market of 2000 to 20002. I suggest you re-revisit your ideas and become acquainted with the fact that whatever you do, you should always use a sell stop; it will save your bacon many times.

Your investing style is based on a bullish scenario, which will get clobbered in a bear market environment as you have witnessed. I believe that the bear has a long ways to go, but if I’m wrong, then trend reversals, as shown via my Trend Tracking Indexes (TTIs), will give you the opportunity to re-enter the market at a time when the odds are stacked in your favor.

As I suspected, the market did the old pop and drop over the past 2 days, and gave back all, and then some yesterday, of what was gained the day before. So much for the euphoria surrounding the Fannie/Freddie bailout announcement.

Contributing greatly to the weakness in the financial sector was Lehman’s drop of 45% in share price value after it become known that their capital hunting efforts around the world to shore up their balance sheet may have come to an end as a Korean bank backed away from a deal.

The question in my mind is now whether Lehman is big enough to be bailed out and then WaMu, followed by who knows. When will it end? Companies that are no longer a viable businesses entity should be allowed to fail as is customary and healthy in any capitalistic society.

Yesterday’s sharp retreat was a disappointment for many investors who had hoped that a turn-around maybe close at hand. On the contrary, we actually slipped deeper into bear territory with our Domestic Trend Tracking Index (TTI) now having dropped -3.44% below its long term trend line while the International TTI has dropped -10.73% below its own divider between the bullish and bearish zone.

Being on the sidelines remains the best course of action.

Euphoria reigned on Wall Street yesterday as a sharp opening rally gave way to a drop and a subsequent recovery, all caused by the government bailout plan of Fannie Mae and Freddie Mac.

Over the next few days, when more details become known, the markets may react to the reality of what really happened. The government bailed out an institution that should have been allowed to fail. This artificial prop-up will do nothing for homeowners, foreclosures, the credit crisis or the recovery of real estate in general. It was simply designed to throw a lifeline to an institution in order to protect the financial system. Nothing more, nothing less.

Of course, the total expense of this venture is the dark horse here, but what’s a few hundred billion dollars among friends? Eventually, we all get to participate in paying for this newly created monster.

The old adage “watch what they do, not what they say,” certainly rang true over the past few weeks leading up to this takeover event. Mish at Global Economics posted a great analogy in case you are not sure what politicians really mean based on what they’re saying. You can read it at “Paulson And Others Translated.”

Be sure to watch the music video referenced at the end of the post with the appropriate title “Take a load of Fannie.” It hits the nail on the head with a classic song, which is funny, sad and true.

In case you’re wondering, this rebound did nothing to change the direction of our Trend Tracking Indexes (TTIs), which are still under water and in bear territory:

Domestic TTI: -2.00%
International TTI: -8.23%

New reader Lloyd had this experience to share:

I invest in mutual funds and ETFs. I was using Fidelity funds and using the 1 mo, 3 months, and 1-year returns to pick the best performing funds.

This seemed to work okay, but recently it had me in all oil and oil related funds and when oil dropped I lost all my profits. I was wondering if your method would do the same or would it get me out with some profit. Also, what do you use for a sell signal for the sector ETFs and sector mutual funds?

I was looking at your M-Index and wondering why you use YTD in your calculations rather than 1 year. It seems to me that if you use YTD, you’re not always using the same number of months to make your calculations. The last month of the year the YTD is 12 months of data whereas the first of the month of the year the YTD is only one month. Does this affect the ranking?

First, using longer term momentum figures as Lloyd suggests can work as well. However, you still need to pay attention to the direction of the trends and follow a strict sell stop discipline. Just because momentum figures are still in positive territory does not mean holding a fund/ETF is advisable.

Once you have established your invested position, you need to set up your trailing stop loss point. For sector and country funds, I use 10% and for domestic and broadly diversified international funds I use 7%. Without it, you are exposing yourself to tremendous risk no matter which investment approach you use.

Second, you are correct in your observation that the value of the M-Index is reduced to a smaller number every January due to the new YTD returns. Since all M-Indexes for all ETFs/Mutual Funds are adjusted at the same time, it really does not really matter since the figure by itself has no meaning. It is only important when compared to others and shows increasing and decreasing momentum.

Again, when working with momentum figures or trends in general, the implementation of a sell stop discipline will save your portfolio from major damage. Unfortunately, many Buy & Hold investors have not figured that out yet and will have to learn the hard way (by losing serious money) that a bear market is not to be taken lightly.

The fallout from the credit crunch has been well documented, because the top names in investment banking had to cumulatively write down so far in excess of some $500 billion dollars with no end in sight. In case you missed it, Merrill Lynch has held the dubious #1 ranking when comparing losses to historical profits.

News reports had this to say (sorry, no link available):

Merrill Lynch’s losses in the past 18 months amount to about a quarter of the profits it has made in its 36 years as a listed company, according to Financial Times research that highlights the extent of the global banking crisis.

UBS, which has lost more than $15 billion during the crisis, had the second-highest ratio.

[Emphasis added]

This describes investment banking in a nutshell, as I have posted about previously. Companies use sophisticated computer models that can make tremendous amounts of profits but rely on computations and assumptions which do not include the rare Black Swan event.

Every so often a blow up occurs, which has the potential to completely wipe out companies, such as happened with LTCM (Long Term Capital Management) in 1998, when a stable of the brainiest investment people along with Nobel laureates placed ill-timed trades without a plan to exit in case their assumptions proved incorrect. I reviewed the book in “When Genius Failed.”

Nassim Taleb writes in “Fooled by Randomness” that this is a frequent occurrence and no one seems to have learned from the past. He states that simple techniques such as using sell stops are rarely used by “professionals.” Hard to believe, isn’t it?

Recent news reports state that Merrill is still having problems unloading some troubled holdings. Undoubtedly, this will continue until every company owning garbage assets has finally cleaned up their balance sheets.

Common sense would dictate that coming clean all at once, spilling your guts and getting it over with would be the fastest way to a new beginning rather than hanging on to continuously deteriorating toxic holdings. Maybe some of the companies would prefer that approach, but can’t.

Why?

Could it be that if they produced a “marked to market” type balance sheet that it might disclose that they are no longer a viable entity?

MarketWatch featured an interesting story titled “Is that deflation we smell?” Let’s listen in:

What do you call it when both stocks and commodities are plunging?

Unless Fed chairman Bernanke can pull more rabbits out of his hat, and soon, we should probably prepare ourselves for more days like Thursday.

I agree with that assessment, because it should not be earthshaking news to anyone that, with the continuing destruction of assets across corporate America, deflation has taken a firm hold. With the continuing unwinding of the credit bubble, the Fed is pretty helpless but to let the current scenario run its course. The question in my mind is just which entity will be big and important enough to get bailed out and which one with be not worthy of that option.

While I personally do not support any kind of bailout (because tax payers will be on the hook), choices will have to be made. Given the enormity of the credit crisis, even the Fed’s balance sheet has limits.