I have always maintained that country ETFs are a leveraged play on the United States. In other worlds, when the big dog goes down, so will most of the rest of the world.

One reader had this to say:

Would like to have your thoughts on ILF. Though your trend tracker indicates being out of the market for international ETFs, can investors still invest in ETFs which are trading above their 200 day MA? For example, ILF trades just above its 200 day MA. Is it prudent to invest in such ETFs or not?

Let’s look at a chart of ILF first:

The price has clearly broken its long-term trend line to the downside by -2.14%. The high for the year occurred on 5/19/08 and since then, ILF has dropped some 16.65%.

Unless you are an aggressive bottom picker, which I don’t recommend, this fund has entered bear market territory, following the U. S. market with some delay. Personally, I would not buy ILF until it crosses its long-term trend line to the upside, which should be accompanied by our domestic Trend Tracking Index (TTI) turning bullish again.

Remember what happened with the China Fund (FXI), where many investors got their head handed to them on a silver platter as they tried to engage in bottom fishing.

I am sure that you have read various references online and in other news media where derivatives have been referred to as financial WMDs (Weapons of Mass Destruction). I think the term was originally coined by none other than Warren Buffett.

To find out more about it, and to get some inside scoop as to the goings on in that area, I just finished reading Satyajit Das’ fascinating book “Traders, Guns and Money.”

The author is an international expert in the dazzling world of financial derivatives and has 25 years experience in the financial markets. He has had a foot on both sides of the derivatives equation, having worked for banks (the “sell side”) such as the Commonwealth Bank of Australia, Citicorp Investment Bank and Merrill Lynch and, as Treasurer of the TNT Group, for clients (the “buy side”). He now acts as a consultant advising banks and corporations and presenting seminars throughout the world on the slippery subject of derivatives.

Derivatives for the most part are unknown unknowns. Here’s an example and a humorous explanation of that term for anybody, especially women, to understand:

In most businesses, the nature of the product is a known known. We do not spend a lot of time debating the use of or our need for a pair of shoes. We also understand our choices—lace up or slip-on, black or brown. I speak, of course, of men’s shoes here.

Women’s shoes, well, they are closer to derivatives. The derivatives sales process is more complex. You may not know that you need the product—an unknown known. You probably haven’t got the faintest idea of what a double knockout currency option with rebate is or does—a known unknown. What should you pay for this particular item? Definitely, unknown unknown. Derivatives are similar to a Manolo Blahnik or Jimmy Choo pair of women’s shoes.

This book is a sensational and controversial account of the often dazzling business of derivatives trading. No money is ever really made in financial markets. Markets merely transfer wealth. As to how to make money? Well, it is basically theft, misrepresentation, lies, cheating, deception or force.

It is impossible to make the staggering amounts made in derivatives in good years honestly.

The book is a wry and wickedly comic expose of the culture, games, and pure deceptions played out every day in trading rooms around the world, usually with other people’s money. Even though you do not need to follow every derivative example shown, it’s a fascinating read guaranteed to make you think.

I’ve received a lot of reader comments and questions during these uncertain times with one reader asking: “Can you not post more frequently during these turbulent times giving your views on what the market is doing and where it is headed?”

Because you ask that question, I believe that there a few things wrong with your approach to investing. I already post once a day, just about 365 times a year. For the strict purpose of following my trend tracking methodology, that is way more than necessary. A commentary once a week and somewhat more often as we approach potential buy and sell signals, would be totally sufficient.

The remainder of my posts are dealing with items of interest and investment philosophy as well as “how to” subjects. My objective is not to regurgitate daily financial news, which you can read anytime at your favorite web site. The goal is to comment only on those events that have a direct impact on our investment plans. Everything else represents Wall Street noise and is immaterial.

As you know, I don’t believe in predictions, and I have no idea where the markets will be at next week, next month or how long the current bear market will last.

Based on your question, I have to assume that you are drowning in information overload and may even be getting some enjoyment out of it. You are probably putting too much weight on daily useless information, and I’m guessing that you are spending considerable time digesting it.

What the market does throughout the day, or most of the time even during the week, is pretty inconsequential to our plan unless we are approaching major inflection points. You need to simplify your approach by only focusing on the events (major changes in trend direction) that matter.

Here’s how I do it. Right now, both Trend Tracking Indexes (TTIs) are in bear market territory and the recommended position is to be on the sidelines in money market. As I have pointed out repeatedly, we are holding some small positions in gold, Swiss Francs and a mutual fund hedge. Our stop loss points are being tracked daily, but until the markets make a major and sustained move to one side or the other, there is not much else we can do.

Since I don’t control market behavior, nor do I have any inside knowledge as to what will be happening next, I have to wait for the trend to establish itself before I can make my next decision. I suggest you follow a similar pattern, in order to get away from the apparent need to be constantly bombarded with market information.

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

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

The bulls found reasons to rally this week aided by lower oil prices and financial news that was not as bad as expected.

Our Trend Tracking Index (TTI) for domestic funds/ETFs remains below its trend line (red) by -3.43% thereby confirming the current bear market trend.



The international index dropped as well and now remains -9.20% below its own trend line, keeping us on the sidelines.

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

As a regular reader, you will undoubtedly have noticed that our international Trend Tracking Index (TTI) dove off the cliff after our Sell signal back on 11/13/07, while the domestic TTI tried to stay above water before finally succumbing to bearish forces. If you are not familiar with the charts, you may reference section 1 and 5 of the latest StatSheet.

Reader Ray had this comment:

Since your sell 11/13/2007 on the international index it has fallen off a cliff. It seems that it would take quite a long time for the index to recover and position itself in a buy mode. The domestic index is not in the same pattern, and is almost 10 percentage points closer to its line.

I hope this question is not confusing.

Over the past 20 years, I have not been able to establish a direct relationship between the two indexes. I have noticed, however, that once the international TTI signals a buy, at least in the past, it tended to stay in that mode for a longer time period then the domestic market. In that sense, it almost behaved like some currencies, which tend to stay in certain patterns for several years.

Essentially, we have had time periods where the international TTI signaled a buy, which was followed by a domestic buy and vice versa. There also have been periods where we received a buy domestically, and the international market did not follow at all.

You never know. During 2006, we received an international buy first, and I allocated 33% of portfolio value to that area. A month later, the domestic market kicked in, and I allocated 33% there as well. As time went on, I added a few sector and country ETFs to reach a 100% invested position.

Had I only received one buy signal, my investment process would have been the same. First, I would have allocated 33% and then added to those positions that were gaining in value (5% gain) eventually reaching the 66% invested level. With the remaining 33%, I would have again looked for opportunities in sectors and countries.

Another alternative might have been to incrementally increase your position to 100% without using any sectors or counties. There is no right or wrong here, it would simply be a matter of preference and risk tolerance. No matter which way you decide to proceed in the future, using my recommended sell stop discipline is of utmost importance.

Reader Ray had some interesting observations about the market, very similar to what many others have voiced. Here’s what he had to say:

I feel I am like most investors and most of us are very conflicted in a bear market, as I, most of us feel it will end without being properly positioned for the next up move. (LOOK OUT– EMOTIONS AT HAND) Most of us (like most humans) are positive, optimistic long only investors, and this bear market is difficult to be patient with.

With that said, it has also been demonstrated that you can have some very violent moves to the upside in a bear that appear to leave you in neutral as the market advances only to suck you in at the end of the move with another leg to the downside (financials from Jan 12 to end of the quarter– THEN SMASHED).

Even your last buy was met with a whipsaw, but to your credit, out again before the major damage was done. The hardest thing to do is take a loss for me and therefore mutual funds have offered the best risk adjusted vehicle. I have learned this after some devastating losses in individual stocks– tech heavy in 2000, fooled by dividends i.e. financials or any other excuse to stay in a loser.

My lament is that I was not able to recognize this bear earlier and position myself in those sectors that were deteriorating and take advantage of this wonderful opportunity to add another risk adjusted strategy—-short.

As you can tell by my comment that I am not short, but I am majority cash. Is it too late? My feeling is that a DOW 14,265 now 11,000 it probably is. The real question is how did I miss the opportunity to take advantage of that 3000 point move to the downside that seems so obvious (in hindsight) in retail, finance, homebuilders etc.

I also agree with your point that this bear could be much longer and much more severe because of such a strong move from the beginning of 2003. I state that because I am still wondering if it is too late to position a short?

Great work to get us in cash so soon after that last up signal.

My view is that I’d rather be a little late to the party than too early. I have received some reader email who admitted having shorted the markets heavily a couple of months ago, only to be caught on the wrong side during the rebound rally.

When the domestic Trend Tracking Index (TTI) breaks below its trend line into bear market territory, it’s a buy signal similar to the TTI breaking above it. The only difference is that you’re buying inverse funds/ETFs which gain as the markets fall.

You still need to apply the same discipline by allocating an amount to short funds that you are comfortable with. That could mean 10 – 20% of portfolio value, or more, if you have a higher risk tolerance. But most importantly, you still need to apply the same stop loss discipline that you use on the long side.

So, is it too late to initiate new short positions now? Looking at the big long-term picture, I see a lot more downside potential. However, that does not mean that there won’t be dead cat bounces, which can stop you out quickly.

As always, your emotional makeup should determine whether shorting the market is for you. As I noted recently in “Is Short Selling Worth It?” long-term the effects of short-selling on your portfolio may not be what you would expect.