Global performance

S&P 500, EAFE, & Emerging Markets - 5 year performance (above).

S&P 500, EAFE, & Emerging Markets - bear market performance (above).

Typically there's a trade-off between performance and volatility, but this bear market has shown there was little benefit shifting assets from EAFE or Emerging Markets to the less volatile S&P 500. I would have thought the EAFE and Emerging Market equities would have taken a much larger hit over this period.

The question in my mind is; will foriegn equities continue to outperform the U.S. in the next bull market?

Week of 7-19-2008

Timing Model = 0.5
60% long, 40% cash

Global allocation of long positions
MSCI EAFE Index 30%
MCCI Emerging Markets Index 20%
Russell 3000 Index - U.S. 50%

Top U.S. Sectors
U.S. Biotechnology 4.5
U.S. Oil Equipment, Services & Distribution 4.0
Precious Metals 3.5
U.S. Oil & Gas 3.0
U.S. Health Care 2.5
Small Cap Growth 2.5
U.S. Leisure Goods 2.0

Top Intl. ETFs
MSCI Canada Index Fund 2
S&P Latin America 40 Index Fund 2
MSCI Brazil Index Fund 2
MSCI Mexico Index Fund 1
FTSE/Xinhua China 25 Index Fund 1

Strategy 3
Money Market 33.3%
Agriculture 33.3%
Precious Metals 33.3%
U.S. Long Bonds 0.0%
Energy 0.0%Industrial Materials 0.0%
Emerging Markets 0.0%
U.S. REITs 0.0%
U.S. Small Cap 0.0%
U.S. Large Cap 0.0%
Intl Real Estate 0.0%
EAFE 0.0%

Week of 7-12-2008

Timing Model = -0.5
40% long, 60% cash

Global allocation of long positions
MSCI EAFE Index 30%
MCCI Emerging Markets Index 20%
Russell 3000 Index - U.S. 50%

Top U.S. Sectors
U.S. Biotechnology 5.0
U.S. Oil Equipment, Services & Distribution 5.0
U.S. Oil & Gas 4.0
U.S. Health Care 3.0
Precious Metals 3.0
U.S. Basic Materials 2.5

Top Intl. ETFs
MSCI Canada Index Fund 3
S&P Latin America 40 Index Fund 2
MSCI Brazil Index Fund 2

Strategy 3
U.S. Long Bonds 20.0%
Money Market 20.0%
Agriculture 20.0%
Energy 20.0%
Precious Metals 20.0%
Industrial Materials 0.0%
Emerging Markets 0.0%
U.S. REITs 0.0%
U.S. Small Cap 0.0%
U.S. Large Cap 0.0%
Intl Real Estate 0.0%
EAFE 0.0%

My timing model continues to suggest increasing less risk in equities - now at 40% long, 60% cash. I don't see a lot of sector rotation lately. Biotech is on a tear and Healthcare has been stuck in a 6% range for the past 4 months, but energy, precious metals, and basic materials are still momentum leaders.

Week of 7-06-2008

Timing Model = -1.0
30% long, 70% cash

Global allocation of long positions
MSCI EAFE Index 30%
MCCI Emerging Markets Index 20%
Russell 3000 Index - U.S. 50%

Top U.S. Sectors
U.S. Biotechnology 5.5
U.S. Oil Equipment, Services & Distribution 5.0
U.S. Oil & Gas 4.0
U.S. Health Care 3.5
U.S. Utilities 3.0
Precious Metals 3.0
U.S. Technology 2.5
U.S. Consumer Services 2.0

Top Intl. ETFs
MSCI Canada Index Fund 3
S&P Latin America 40 Index Fund 2
MSCI Brazil Index Fund 2
MSCI Mexico Index Fund 1

Strategy 3
U.S. Long Bonds 20.0%
Money Market 20.0%
Agriculture 20.0%
Energy 20.0%
Precious Metals 20.0%
Industrial Materials 0.0%
Emerging Markets 0.0%
U.S. REITs 0.0%
U.S. Small Cap 0.0%
U.S. Large Cap 0.0%
Intl Real Estate 0.0%
EAFE 0.0%

Week of 6-29-2008

Timing Model = -1.5
20% long, 80% cash

Global allocation of long positions
MSCI EAFE Index 20%
MCCI Emerging Markets Index 30%
Russell 3000 Index - U.S. 50%

Top U.S. Sectors
U.S. Biotechnology 5.5
U.S. Oil Equipment, Services & Distribution 5.0
U.S. Oil & Gas 3.5
Precious Metals 3.0
U.S. Utilities 3.0
Small Cap Growth 2.0
U.S. Basic Materials 2.0
U.S. Health Care 2.0

Top Intl. ETFs
S&P Latin America 40 Index Fund 3
MSCI Canada Index Fund 3
MSCI Brazil Index Fund 3
MSCI Emerging Markets Index Fund 1

Strategy 3
U.S. Long Bonds 16.7%
Money Market 16.7%
Agriculture 16.7%
Industrial Materials 16.7%
Energy 16.7%
Precious Metals 16.7%
Emerging Markets 0.0%
U.S. REITs 0.0%
U.S. Small Cap 0.0%
U.S. Large Cap 0.0%
Intl Real Estate 0.0%
EAFE 0.0%

A patient model

My gut reaction to periods like this is usually a lot more bullish than my model suggest. We're six weeks into steadily falling prices and sentiment is growing more pessimistic every day. but my model is patient.

By design, my model's sentiment indicators gradually counter trend indicators at market bottoms. A pure trend-following system would always be wrong at tops and bottoms, only to suggest shifts in long/short positions after prices have made significant moves.

As you can see in the screenshot of my model, all four trend indicators are currently at a -1. The sentiment indicators are only slightly bullish, most at a +.5. I score each sentiment indicator slightly different, but the basic principle is:

• If sentiment is exhibiting excessive pessimism but falling, score it mildly bullish
  
• If sentiment is at historical extremes, score it bullish


• If sentiment is excessively pessimistic, but has reversed, begining to show greater optimism, score it as extremely bullish

In my model, trend and sentiment counterbalance each other - yin yang if you will. Usually the sentiment indicators only start to exert bullish weight when the market is growing closer to a market top or bottom. If sentiment reverses, their weighting increases dramatically.

Note the week ending 3/28, where the sentiment indicators went into hyperdrive, overpowering the unanimously bearish trend indicators to push the model to a 70% equity allocation. If you recall that period, most pundits were waiting for the other shoe to drop. Models that include a strong sentiment components can very often get your long/cash allocation right at important turning points.

Below is a chart of my timing model's equity allocation for 2008 vs. the S&P 500.

Week of 6-21-2008

Timing Model = -1.5
20% long, 80% cash

Global allocation of long positions
MSCI EAFE Index 20%
MCCI Emerging Markets Index 30%
Russell 3000 Index - U.S. 50%

Top U.S. Sectors
U.S. Oil Equipment, Services & Distribution 5.0
U.S. Oil & Gas 4.0
U.S. Biotechnology 3.5
U.S. Basic Materials 3.0
Precious Metals 2.5
Mid Cap Growth 2.5
Small Cap Growth 2.5
U.S. Utilities 2.0

Top Intl. ETFs
S&P Latin America 40 Index Fund 3
MSCI Canada Index Fund 3
MSCI Brazil Index Fund 3
MSCI Emerging Markets Index Fund 1
FTSE/Xinhua China 25 Index Fund 1
MSCI Hong Kong Index Fund 1
MSCI Mexico Index Fund 1
MSCI Austria Index Fund 1

Strategy 3
Money Market 20.0%
Agriculture 20.0%
Industrial Materials 20.0%
Energy 20.0%
Precious Metals 20.0%
Emerging Markets 0.0%
U.S. REITs 0.0%
U.S. Small Cap 0.0%
U.S. Long Bonds 0.0%
U.S. Large Cap 0.0%
Intl Real Estate 0.0%
EAFE 0.0%

The sentiment models continue to cycle down ever closer to levels of extreme pessimism. If we don't see a good pop to the upside this week, we should see the all 4 sentment models adding points to my timing model by next week.

Week of 6-15-2008

Timing Model = -2.0

10% long, 90% cash

Global allocation of long positions

MSCI EAFE Index 20%

MCCI Emerging Markets Index 30%

Russell 3000 Index - U.S. 50%

Top U.S. Sectors

U.S. Oil Equipment, Services & Distribution 4.5

U.S. Oil & Gas 3.5

Precious Metals 3.5

U.S. Basic Materials 2.5

U.S. Biotechnology 2.0

U.S. Utilities 1.5

U.S. Health Care 1.5

Top Intl. ETFs

S&P Latin America 40 Index Fund 2

MSCI Canada Index Fund 2

MSCI Brazil Index Fund 1

MSCI Emerging Markets Index Fund 1

FTSE/Xinhua China 25 Index Fund 1

MSCI Hong Kong Index Fund 1

MSCI Taiwan Index Fund 1

MSCI Mexico Index Fund 1

Strategy 3

Money Market 25.0%

Agriculture 25.0%

Industrial Materials 25.0%

Energy 25.0%

Emerging Markets 0.0%

Precious Metals 0.0%

U.S. REITs 0.0%

U.S. Small Cap 0.0%

U.S. Long Bonds 0.0%

U.S. Large Cap 0.0%

Intl Real Estate 0.0%

EAFE 0.0%

Sentiment is neutral but getting to closer to signaling mild over-pessimism. The intermediate term trend is still a bit mixed as the Value Line Composite struggles to keep above its 75 day moving average. Strategy 3 allocations reflect the asset classes everyone has been discussing for many months now: Energy, Industrial Materials, and Agricultural commodities.

Week of 6-8-2008

Timing Model = -1.0
30% long, 70% cash

Global allocation of long positions
MSCI EAFE Index 30%
MCCI Emerging Markets Index 30%
Russell 3000 Index - U.S. 40%

Top U.S. Sectors
U.S. Oil Equipment, Services & Distribution 4.5
U.S. Oil & Gas 2.5
U.S. Basic Materials 2.5
Precious Metals 2.5
U.S. Biotechnology 1.5
U.S. Health Care 1.5

Top Intl. ETFs
MSCI Brazil Index Fund 3
S&P Latin America 40 Index Fund 2
MSCI Canada Index Fund 2
MSCI Austria Index Fund 1
MSCI Emerging Markets Index Fund 1
FTSE/Xinhua China 25 Index Fund 1
MSCI Hong Kong Index Fund 1

Strategy 3
Money Market 16.7%
Agriculture 16.7%
Industrial Materials 16.7%
Energy 16.7%
Emerging Markets 16.7%
Precious Metals 16.7%
U.S. REITs 0.0%
U.S. Small Cap 0.0%
U.S. Long Bonds 0.0%
U.S. Large Cap 0.0%
Intl Real Estate 0.0%
EAFE 0.0%

Week of 6-1-2008

Timing Model = -0.5
40% long, 60% cash

Global allocation of long positions
MSCI EAFE Index 30%
MCCI Emerging Markets Index 30%
Russell 3000 Index - U.S. 40%

Top U.S. Sectors
Mid Cap Growth 3.5
U.S. Oil Equipment, Services & Distribution 3.5
Precious Metals 2.5
U.S. Oil & Gas 2.5
U.S. Biotechnology 2.0
U.S. Semiconductor 2.0
U.S. Technology 2.0
U.S. Basic Materials 1.5

Top Intl. ETFs
S&P Latin America 40 Index Fund 3
MSCI Brazil Index Fund 3
MSCI Canada Index Fund 2
MSCI Austria Index Fund 1
MSCI Emerging Markets Index Fund 1
MSCI Taiwan Index Fund 1
FTSE/Xinhua China 25 Index Fund 1
MSCI Mexico Index Fund 1
MSCI Hong Kong Index Fund 1

Strategy 3
Money Market 11.1%
Agriculture 11.1%
Industrial Materials 11.1%
Energy 11.1%
Emerging Markets 11.1%
EAFE 11.1%
Precious Metals 11.1%
U.S. REITs 11.1%
U.S. Small Cap 11.1%
U.S. Long Bonds 0.0%
U.S. Large Cap 0.0%
Intl Real Estate 0.0%

Week of 5-25-2008

Timing Model = -1.5
20% long, 80% cash

Global allocation of long positions
MSCI EAFE Index 30%
MCCI Emerging Markets Index 30%
Russell 3000 Index - U.S. 40%

Top U.S. Sectors
U.S. Oil Equipment, Services & Distribution 5.0
U.S. Oil & Gas 3.5
U.S. Biotechnology 3.0
U.S. Semiconductor 2.5
U.S. Technology 2.5
Precious Metals 2.5

Top Intl. ETFs
S&P Latin America 40 Index Fund 3
MSCI Brazil Index Fund 3
MSCI Canada Index Fund 3
MSCI Austria Index Fund 2
MSCI Emerging Markets Index Fund 2

Strategy 3
Money Market 12.5%
Agriculture 12.5%
U.S. Long Bonds 12.5%
Industrial Materials 12.5%
Energy 12.5%
Emerging Markets 12.5%
EAFE 12.5%
Precious Metals 12.5%
U.S. REITs 0.0%
U.S. Large Cap 0.0%
U.S. Small Cap 0.0%
Intl Real Estate 0.0%

Week of 5-18-2008

Timing Model = .5
60% long, 40% cash

Global allocation of long positions
MSCI EAFE Index 30%
MCCI Emerging Markets Index 30%
Russell 3000 Index - U.S. 40%

Top U.S. Sectors
U.S. Oil Equipment, Services & Distribution 5.0
U.S. Oil & Gas 4.0
Precious Metals 2.5
U.S. Semiconductor 2.0
U.S. Leisure Goods 2.0
Mid Cap Growth 2.0
U.S. Real Estate 2.0

Top Intl. ETFs
S&P Latin America 40 Index Fund 3
MSCI Brazil Index Fund 3
MSCI Taiwan Index Fund 3
MSCI Canada Index Fund 2
MSCI Austria Index Fund 2
FTSE/Xinhua China 25 Index Fund 1
MSCI Emerging Markets Index Fund 1
MSCI Sweden Index Fund 1
MSCI Mexico Index Fund 1
MSCI South Africa Index Fund 1
MSCI Hong Kong Index Fund 1

Strategy 3
Money Market 11.1%
Agriculture 11.1%
U.S. Long Bonds 11.1%
Industrial Materials 11.1%
Energy 11.1%
Emerging Markets 11.1%
U.S. REITs 11.1%
EAFE 11.1%
Precious Metals 11.1%
U.S. Large Cap 0.0%
U.S. Small Cap 0.0%
Intl Real Estate 0.0%

Week of 5-11-2008

Timing Model = 0
50% long, 50% cash

Global allocation of long positions
MSCI EAFE Index 30%
MCCI Emerging Markets Index 30%
Russell 3000 Index - U.S. 40%

Top U.S. Sectors
U.S. Oil Equipment, Services & Distribution 5.0
U.S. Oil & Gas 4.5
U.S. Biotechnology 3.5
U.S. Basic Materials 2.5
Precious Metals 2.5

Top Intl. ETFs
S&P Latin America 40 Index Fund 3
MSCI Brazil Index Fund 3
MSCI Taiwan Index Fund 1
FTSE/Xinhua China 25 Index Fund 1
MSCI Canada Index Fund 1
MSCI Emerging Markets Index Fund 1
MSCI Sweden Index Fund 1
MSCI Spain Index Fund 1
MSCI Singapore Index Fund 1
MSCI Austria Index Fund 1
MSCI Mexico Index Fund 1
MSCI Belgium Index Fund 1
MSCI South Africa Index Fund 1
MSCI Netherlands Index Fund 1
MSCI France Index Fund 1

Strategy 3
Money Market 16.7%
Agriculture 16.7%
U.S. Long Bonds 16.7%
Industrial Materials 16.7%
Energy 16.7%
Emerging Markets 16.7%
U.S. REITs 0.0%
EAFE 0.0%
Precious Metals 0.0%
U.S. Large Cap 0.0%
U.S. Small Cap 0.0%
Intl Real Estate 0.0%

Week of 5-4-2008

Timing Model = .5
60% long, 40% cash

Global allocation of long positions
MSCI EAFE Index 30%
MCCI Emerging Markets Index 30%
Russell 3000 Index - U.S. 40%

Top U.S. Sectors
U.S. Oil Equipment, Services & Distribution 5.0
U.S. Oil & Gas 4.5
Precious Metals 4.0
U.S. Basic Materials 3.0
U.S. Biotechnology 2.5
U.S. Leisure Goods 2.0
Mid Cap Growth 2.0
U.S. Health Care 2.0

Top Intl. ETFs
S&P Latin America 40 Index Fund 3
MSCI Brazil Index Fund 3
MSCI Taiwan Index Fund 2
FTSE/Xinhua China 25 Index Fund 2
MSCI Canada Index Fund 1
MSCI Emerging Markets Index Fund 1
MSCI Sweden Index Fund 1
MSCI Spain Index Fund 1
MSCI Hong Kong Index Fund 1
MSCI South Korea Index Fund 1
MSCI Singapore Index Fund 1
MSCI Austria Index Fund 1

Strategy 3
Money Market 12.5%
Agriculture 12.5%
U.S. Long Bonds 12.5%
Industrial Materials 12.5%
Energy 12.5%
Emerging Markets 12.5%
U.S. REITs 12.5%
EAFE 12.5%
Precious Metals 0.0%
U.S. Large Cap 0.0%
U.S. Small Cap 0.0%
Intl Real Estate 0.0%

Have Basic Materials Peaked?

The Basic Materials sector plummeted from my top U.S. Sectors ranks this week, so I decided to take a closer look at each model component. My U.S. sector model is heavily weighted towards momentum indicators, but I have built in several other indicators that act as a counterbalance.

Basic Materials have been a top performer over the past 90, 180, and 250 days. By those measures, this sector is a text book candidate to outperform other sectors over the next few months. However, the Basic Material sector also has several technical negatives to contend with.

First, this sector is overbought. Note the pink bands on both the short term and intermediate term TRIX in the chart above. Even in a bull market, overbought conditions usually signal a pause in upward ascent. What I can't show here is a chart from Jason Goefert of Sentimentrader.com (It's a subscription service). The Rydex Basic Materials sector fund assets represents 18.3% of all sector funds. That's pure irrational exuberance. Also, the charts on the Proshares Ultra Basic Materials and Ultra Short Basic Materials Assets illustrate sentiment extremes that don't exactly give a contrarian a warm and fuzzy for further gains.

Extreme optimism is only one reason to raise an eyebrow about Basic Materials. I've studied technical analysis for many years, and one of the few reliable indicators that signal market tops is a long term momentum divergence. In the chart above you can see the 60-130-45 Moving Average Convergence Divergence peaked last July. You can also see $DJUSBM continued to climb to ever higher heights. This is a technician's textbook example of a negative divergence - not exactly a bullish sign.

The last bearish tea leaf is seasonality. Historically, May is the beginning of poor performance for the Basic Materials sector. Given that many economist believe the U.S. is in or near a recession, basic materials doesn't seem to be a great place to be for the next few months.

I'd love to hear your thoughts.

Week of 4-27-2008

Timing Model = 1.5
80% long, 20% cash

Global allocation of long positions
MSCI EAFE Index 30%
MCCI Emerging Markets Index 30%
Russell 3000 Index - U.S. 40%

Top U.S. Sectors
U.S. Oil Equipment, Services & Distribution 5.0
Precious Metals 3.5
U.S. Biotechnology 3.5
U.S. Oil & Gas 3.5
U.S. Real Estate 2.5
U.S. Leisure Goods 2.5

Top Intl. ETFs
S&P Latin America 40 Index Fund 3
MSCI Brazil Index Fund 3
MSCI Taiwan Index Fund 2
MSCI Mexico Index Fund 1
MSCI Canada Index Fund 1
MSCI Emerging Markets Index Fund 1
FTSE/Xinhua China 25 Index Fund 1
MSCI Sweden Index Fund 1
MSCI Spain Index Fund 1
MSCI Hong Kong Index Fund 1
MSCI Belgium Index Fund 1

Strategy 3
Money Market 12.5%
Agriculture 12.5%
Precious Metals 12.5%
U.S. Long Bonds 12.5%
Industrial Materials 12.5%
Energy 12.5%
Emerging Markets 12.5%
U.S. REITs 12.5%
EAFE 0.0%
U.S. Large Cap 0.0%
U.S. Small Cap 0.0%
Intl Real Estate 0.0%

My timing model continues to lose points as pessimism burns off from the bottom we saw in early March. Unless the S&P 500 and Value Line composite breach their 200 day moving average fairly soon, I expect my timing model to continue to shed exposure to equities.

U.S. REITs have just broke above their 200 day moving average and have earned a long postion in strategy 3. Let's see how long that lasts.

Week of 4-19-2008

Timing Model = 3.5
100% long, 0% cash

Global allocation of long positions
MSCI EAFE Index 30%
MCCI Emerging Markets Index 30%
Russell 3000 Index - U.S. 40%

Top U.S. Sectors
U.S. Oil Equipment, Services & Distribution 5.0
U.S. Oil & Gas 5.0
U.S. Biotechnology 4.5
U.S. Basic Materials 4.0
Precious Metals 3.5

Top Intl. ETFs
S&P Latin America 40 Index Fund 3
MSCI Brazil Index Fund 3
MSCI Taiwan Index Fund 2
MSCI Mexico Index Fund 1
MSCI Canada Index Fund 1
MSCI Emerging Markets Index Fund 1
FTSE/Xinhua China 25 Index Fund 1

Strategy 3
Money Market 14.3%
Agriculture 14.3%
Precious Metals 14.3%
U.S. Long Bonds 14.3%
Industrial Materials 14.3%
Energy 14.3%
Emerging Markets 14.3%
EAFE 0.0%
U.S. Large Cap 0.0%
U.S. Small Cap 0.0%
U.S. REITs 0.0%
Intl Real Estate 0.0%

Strategy 3.1

I'm adding two new asset classes to strategy 3; energy and international real estate. There are now twelve asset class represented. All asset classes above their 200 day moving average share an equal position size.

Money Market 16.7%
Agriculture 16.7%
Precious Metals 16.7%
U.S. Long Bonds 16.7%
Industrial Materials 16.7%
Energy 16.7%
Emerging Markets 0.0%
EAFE 0.0%
U.S. Large Cap 0.0%
U.S. Small Cap 0.0%
U.S. REITs 0.0%
Intl Real Estate 0.0%

Week of 4-13-2008

Timing Model = 2.5
100% long, 0% cash

Global allocation of long positions
MSCI EAFE Index 30%
MCCI Emerging Markets Index 30%
Russell 3000 Index - U.S. 40%

Top U.S. Sectors
U.S. Oil Equipment, Services & Distribution 5.5
U.S. Biotechnology 4.5
U.S. Basic Materials 4.5
U.S. Oil & Gas 4.5
Precious Metals 3.5
U.S. Semiconductor 3.0

Top Intl. ETFs
S&P Latin America 40 Index Fund 3
MSCI Brazil Index Fund 3
MSCI Taiwan Index Fund 2
MSCI Mexico Index Fund 2

Strategy 3
Money Market 20.0%
Agriculture 20.0%
Precious Metals 20.0%
U.S. Long Bonds 20.0%
Industrial Materials 20.0%
Emerging Markets 0.0%
EAFE 0.0%
U.S. Large Cap 0.0%
U.S. Small Cap 0.0%
U.S. REITs 0.0%

Watching for a trend reversal

Yesterday the Value Line Composite Index closed above it's 75 day moving average. The 75 dma of the Value Line is one of four trend indicators in my timing model. If this index can stay above this level today it will raise my model reading from a +1 to a +2, suggesting a 90% allocation to stocks. The S&P 500 is still below it's 75 day moving average.

I point this out because my model is set up to defer to it's trend indicators as bullish (extreme pessimism) sentiment readings begin to lose strength/relevance. The trend indicators will either kick in or the model will begin to turn bearish. My guess is we will see some consolidation near term, but we will head to higher levels over the the next month or so. I also believe we are still in a bear market but my model has an intermediate term orientation, so it is possible to go heavily long.

Trend indicators are very sensitive and whipsaws should be expected. I usually deal with junctures like this by shifting some assets to a double long fund (such as ULPIX) instead of opening a new position in a sector or country ETF. By holding small positions in double long/short funds I can adjust to small changes to my model without generating a bunch of trades.

Here's an under the hood look at my TAA portfolio as of yesterday's close: