In my recent post about the potential Chinese bubble, reader Ron responded that stock markets can’t be controlled by governments.

While that may be true, government decisions or policy changes, however, can be just as effective in controlling market direction. Such was the case yesterday when the Chinese government announced a tripling of the tax on stock trading to curb excessive speculation. The response was swift as the Shanghai Index lost 6.5% for the day.

Most world markets joined in the early sell off, but recovered later on and, in the case of the S&P; 500, a new lifetime high was made. The chart below shows yesterday’s price activity of the Shanghai Index vs. the S&P; 500:

I referenced articles from fool.com before, but their latest one did not sit well with my kind of thinking. It’s titled “Great Investments for Busy People” and quotes Vanguard founder John Bogle as saying that mutual funds were the finest vehicles for long-term investing ever designed. I can agree with that and realize that his statement was probably made prior to the ETF revolution.

The article goes on to list a few items of importance for you, the busy professional, to look at when evaluating mutual funds. Here’s what it says.

Among other things, when you’re in the market for a mutual fund, you should ask:

1. How long has the fund’s manager been at the helm? At least five years (and preferably longer) is the answer you’re looking for here.

2. How has the fund fared on that manager’s watch? Past performance doesn’t tell you a thing about a fund’s prospects if it doesn’t reflect the work of its current stock-picker-in-chief.

3. Does the manager invest in his or her own fund? If not, why should you?

4. How has the manager fared in up markets and down? When you have a talented manager at the helm, market slumps can represent prime buying opportunities — and juicy gains for shareholders over the long haul.

While I am not totally in agreement with any of the points made, the last one in particular shows the usual ignorance. Okay, some fund managers do better in up markets than others. However, when a prolonged down market hits, it doesn’t matter whether the manager is “talented” or a “beginner.”

Why?

If a fund’s objective is to be long in the market, all portfolio holdings will head south in a bear scenario. Talent and experience won’t help. Unless, of course, the “talented” manager is able to outperform the S&P; 500!

Huh?

Say, the S&P; lost some 20% in a bear market year, and the “talented” manager “only” lost 18%. This performance would most likely elevate him to hero status in the perverse way Wall Street keeps score.

If you had owned the fund that lost “only” 18%, would you be feeling like a hero too?

MarketWatch had a story on Vanguard’s filing of a new ETF tracking the well known MSCI EAFE Index (Morgan Stanly Capital International Europe, Australia, Far East Index).

The buzz is that it will be a directly competing product with Barclay’s well known iShares MSCI EAFE fund better known as EFA. This ETF has been well liked by many investors, and it has grown in size to some $45 billion.

So what’s the big deal?

For one, as could be expected, Vanguard’s filing stated an annual “expected” expense ratio for the new ETF of only 0.15%. Compare that to iShares EFA of 0.35% and you can see that this has the potential of a real competitive battle.

That doesn’t mean that I will jump right in and buy it. As is my habit in my advisor practice, I’d like to see a few months of price data so that I can track the trend. Nevertheless, this new competing product, with less than 50% of the fees, is a great step in the right direction of benefiting the investing public.

Now, if only mutual fund companies would notice.

A couple of weeks ago, the WSJ featured another article comparing Index Funds and ETFs titled “A Close Race, a Surprising Finish.”

With the help of Morningstar, they crunched some ETF numbers all the way back to 1997 and looked at before and after-tax returns. The ‘before-tax’ analysis is shown in the table below (double click to enlarge):

During the last week, a few newsletter readers had questions about the use of sell stops as they pertain to my trend tracking methodology.

Here’s one e-mail:

I have some mutual funds that are in nose bleed territory, and I have mental sell stops which are about 6-8% below current price.

Also, you mentioned in one of your articles setting an upside and a downside sell point. Could you elaborate?

Let me clarify, since this is an important issue.

For domestic funds/ETFs, your trailing stop should be 7% below the “high price” the fund/ETF made “after” you bought it. You don’t compute it from the current price, unless you just purchased it.

Also, be sure to consider any fund distributions since they have an effect on your sell stop point. I’m not sure what you mean by your funds being in nose bleed territory; if you use the sell stop discipline, this will never happen.

When selecting funds, use the StatSheet as a guide and make your selections based on your risk tolerance. In other words, if you are conservative, don’t pick very volatile sector or country funds.

The upside sell on any of your funds would be the trailing stop loss (7%), which eventually will get you out of the market, provided you follow the signal. Or, if our TTI (Trend Tracking Index) gives a sell first (unlikely) then that would be the overriding factor.

The downside sell occurs if the market goes straight down after your purchase of a fund/ETF; the 7% sell stop will serve to limit your losses.

With the markets having been in a rally mode for the past 9 months, some of your no load fund/ETF holdings are most likely showing different gains. If you listen to some of the media, however, you should sell your laggards and load up on the winners.

While it’s certainly advisable during an uptrend to sell an underperformer (I have done that too by liquidating SWHEX), it is not smart to swap a large portion of your portfolio for the latest and greatest no load fund or ETF. While it may be tempting to play performance catch-up, this can be a two-edged sword. Just because your best friend was fortunate enough to pick better performers than you did last year, doesn’t mean that it is the right thing for you to do at this time.

Why?

For one, when the market turns, and it will, those top performers will be hardest hit and can turn your slowly accumulated gains into losses. Two: if the market defies all odds and continues its upward path, you may see some sector rotation due to the ever changing economy, which may cause some of your laggards to pick up some steam.

So, when is the time to make major adjustments? If you’re following my trend tracking approach, the best time is at the beginning of a Buy cycle. That’s when you need to determine your risk tolerance before you select the funds/ETFs to be invested in.

Remember, this is not a life or death decision in that you’re not holding these funds forever (as you might with Buy & Hold). Your plan should be to select those with a focus on an average Buy cycle duration, which historically has been some 14 months.

I have to say that in my advisor practice (with the benefit of hindsight) my selections last year were very much on the conservative side, and I have made some adjustments to account for stronger performing sectors. However, trying to revamp an entire portfolio at these lofty levels, by shifting into a more aggressive mode, would be a disservice to my clients and would definitely not be in their best long-term interests.