Yesterday’s market bounce, although on low volume, was a step in the right direction. It’s too early to tell if this is the beginning of another uptrend or just a head fake. Many traders are still on vacation and will not be back to their desks pushing buy and sell buttons till after Labor Day. Until then, any moves to the upside or downside may not have much meaning.

The Trend Tracking Indexes (TTIs) are now situated relative to their long term trend lines as follows:

Domestic TTI: +2.30%
International TTI: +0.46%

As you can see, the International TTI recovered and barely broke back above its long term trend line. To avoid a whipsaw, I will hold off making any commitments in that arena until I can better determine if this is a sustainable trend or simply sideways action.

I am looking at some sector opportunities and may make some investments in those areas that have best withstood the recent sell off.

I like some of Paul Farrell’s articles. While I can’t for the life of me agree with him on his investment strategies (hold your coffee house portfolio through any market condition), he wrote a fine piece called “Meltdown ‘inside’ Wall Street’s brain.”

He outlines the self-serving and brain washing acts that come with Wall Street’s manipulation, which I have touched on before in various posts. He offers “seven rules (out of 25) for bull-and-bear predators in a ‘brutal, manipulative’ world.”

While it’s a fun read, his conclusion that you must “redefine the rules of engagement and play the game by your rules,” will leave you wondering what the rules are that you should play by.

In my view, it’s certainly not the trap of Buying and Holding a coffee house portfolio blindly through the next bear market. That would be falling into Wall Street’s self serving trap of staying with a losing investment no matter what. Since most investor’s use mutual funds as their preferred investment tool that means you are still paying the company that loses money for you.

If your preference is ETFs, you won’t be paying anybody, but if you’re ignorant of trends you have nobody to blame but yourself when you get mauled by the bear, unless you have a disciplined exit strategy in place that you will actually execute.

Yesterday’s market activity had no effect on our investment plans despite the ever present volatility. I am in still in a holding position waiting for the markets to decide on future direction before making any further adjustments.

The Trend Tracking Indexes (TTIs) are situated relative to their long term trend lines as follows:

Domestic TTI: +1.47%
International TTI: -0.74%

I did liquidate a few of our tax-free closed end fund holdings since some of them had declined beyond what is acceptable, which was caused by the credit crunch (interest rate gyrations) from the subprime fallout.

CNNMoney featured an excellent article called “Why the private equity bubble is bursting.”

It recaps the insane leveraged buyout fever of the past couple of years which caused some unintended consequences while fueling the stock market rise into record territory. It’s well written and gives you a better understanding of why the bubble is bursting.

There is some focus on the effects of the subprime debacle and why hedge funds will be hit in a big way as the final paragraph explains:

“The biggest losers, though, are likely to be the swashbuckling hedge funds that gorged on high-yield debt and did it in the most reckless way possible. To amp up their returns, they borrowed heavily to buy the bonds of already highly leveraged companies. That’s piling risk on top of risk in a rickety structure that a slight bump can topple. Wall Street firms promoted the practice. Not only did they sell high-yield bonds to the hedge funds, they also lent them money through their prime brokerage arms to buy the bonds on margin. It wasn’t uncommon for the funds to borrow 80% of the price of the loans. With that kind of leverage, for example, they could earn 18% or more owning bonds with a nominal interest rate of 10% or so.

The same leverage that magnified their returns will multiply their losses, with potentially dire effects. Here’s what the worst-case scenario might look like: As the hedge funds get margin calls from Wall Street, they’re forced to dump their holdings of loans and bonds to raise cash. The glut of distressed debt for sale crashes prices and pushes yields to towering levels. Then everyone holding high-yield debt, from Asian banks to small investors with money in junk-bond mutual funds, will take a horrendous pounding.

What we’re seeing here is simply sanity returning to the market. And as always in the aftermath of a bubble, sanity returns the hard way.”

The entire article, while lengthy, reads like a science fiction story and will definitely make you realize that, based on the bursting of the private equity bubble, the stock market may very well be the next victim. It’s hard to see at this time where the fuel for another rally will be coming from.

Recent violent market activity could possibly indicate the end of the uptrend, but we will wait to be sure, via the guidance that our Trend Tracking Indexes provide, before taking final measures to protect our portfolios.

I received the following e-mail from reader Rich:

“Thanks for your rational take on the market & its current woes. I happened to mention the need for a look at what US Government lending regulation might have prevented & nearly got fired on the spot this week. I recall mentioning this in my College Economics curriculum years ago & the response was calmer, if stoic.

However, if there were limits to the types of lending these institutions have been offering, such as there is concerning the use of fireworks on a local basis, perhaps not only personal safety would prevent loss, but financial as well as high hopes for the American Dream, might be limited.

The most clear example is lending without restrictions on income as well as debt to income. Many more follow but at this time even the Fed wants to shore up lending confidence. Too bad is has to happen this way. It is entirely a reaction rather than an action which could have been helped by just a small bit of regulation.

A bulwark if you will against massive individual losses in addition to institutional bankruptcy proceedings.

I’m just fine, but I wonder how my children, were they of an age to sign onto one of these shady loans, might have ended up.”

Rich’s arguments made me reflect back some years ago when interest rates dropped sharply and real estate prices started to head into orbit. For any asset to increase in value there has to be demand, which is reflected in the stock market via volume. Generally speaking, high volume translates into higher prices, while low volume reflects stagnation or lower prices.

In real estate, demand starts at the entry level. Many first time buyers (volume) shopping for homes give existing home owners the opportunity to sell at a profit and move up in the housing food chain. Subsequent lax lending standards allowed mortgage companies to increase the volume of first time buyers by making “fog up the mirror” home loans and thereby adding a huge number of buyers to the market place, who previously did not exist. The result was an ever increasing price spiral until the point was reached where volume dried up—a classic Ponzi scheme.

My thought is this. If we had had strict lending standards back then, I have to wonder if real estate prices would have ever reached the lofty levels that we ended up with. While no one has the answer, there is a chance, however, that prices might have hit a glass ceiling a long time ago. So, in some perverse way those of us that owned real estate were the unintended beneficiaries of the artificially created volume due to subprime loans. Otherwise, you might have never seen your home triple or quadruple in value.

This is not meant to be a justification for subprime loans, just a reflection of what might have been.

Why look at it now?

Because once the total severity of the subprime debacle has been recognized, publicized and “fall guys” identified, you can be sure that, for the time being, marginal home loans will be a thing of the past. The pendulum always swings from one extreme to the other.

The obvious conclusion is that real estate volume will be greatly reduced, which in turn will affect the ability of (average) people to sell their homes quickly to move on to greener pastures. Some will ‘have to’ sell due to job transfers and lack of demand will pull prices lower. How low, no one knows.

My point is that we all have benefited from the subprime debacle and as long as we own real estate, we will be forced to participate in the unraveling.

That’s my view, what’s yours?

Mark Twain said it best in this quote: “When you find yourself on the side of the majority, it’s time to pause and reflect.”

To my way of thinking, this certainly holds true when it comes to handling your money. There are few advisors and others who don’t believe in the Wall Street induced herd instinct type of investing. It has proven to be one a sided “win” situation with the masses of investors usually being left stranded on the street licking their wounds after another failed attempt to stay fully invested during a bear market.

If you are new to investing, these words may not mean much to you because you haven’t lost enough money to appreciate them. If you’ve been around the block for a while (translation: a severe bear market), you should have learned (hopefully) how to adjust your investment approach.

One of the books I referred to in a recent post to on this subject was Al Thomas’s “If It Doesn’t Go Up, Don’t Buy It.”

While Al covers a variety of investment areas, the book is easy to understand and contains words of wisdom from over 40 years of exposure to the financial industry. He has no ax to grind and no allegiances. He calls it as he sees it, which is very rare, nor does he care if anybody is offended, which makes him my kind of a guy.

I have gone through his mutual fund section, which advocates trend tracking, and picked out a few gems that you might consider adapting:

1. Mr. William O’Neil, on of the market technicians and found of Investor’s Business Daily, did a study that found that between 1953 and 1993, 67% of the move upward in any stock can be credited to the positive advance of the Industry Group of the Market Sector to which it belongs.

3. Another great fallacy of the mutual fund gurus is “expense ratios.” They tell you not to invest in any fund that has expenses over 1-1/2%. Who cares what the expense ratio is if that fund makes 40% or more annually? The same for 12b-1 expenses. Who cares? Show me the bottom line. That’s all that counts. Basic rule: Follow the money!

Even though Al’s book was written years ago, his wisdom gained by years in the trenches is simply timeless. It advocates exactly what I have been saying in my weekly updates and in my blog: Focus on being invested only during up trends in the markets, avoid the bear at all costs and disregard Wall Street’s self serving stories.