Ulli...The Wall Street Bully — insights into no load mutual fund/etf investing

A Lot Of Green

ulli-niemann@att.net (Ulli...The Wall Street Bully) — Tue, 10 Nov 2009 13:36:00 +0000

From the moment the markets opened yesterday, it was up, up and away with the Dow hitting a new high for 2009.

Friday’s unemployment figure of 10.2% contributed in a perverse way to yesterday’s rally supporting the view that with such dire news, interest rates will have to stay low for some time to come, which bodes well for stocks.

Additional market support came from the G-20 via an agreement over the past weekend to keep the stimulus programs going. That’s all that was needed, and the major averages never looked back.

I took the opportunity early on yesterday morning to add some new positions, in essence replacing those that we were stopped out of during the last pullback. Of course, all sell stop points have been identified and will be executed when necessary.

While the stamina the market has shown is simply amazing, I have to wonder how long it can last. Since no one has the answer, we will simply follow the trend until the end when it bends.

Price Discrepancies

ulli-niemann@att.net (Ulli...The Wall Street Bully) — Mon, 09 Nov 2009 13:39:00 +0000

While ETFS have many advantages over mutual funds, they have not been around long enough to address all issues that might affect their NAVs as Seeking Alpha reports in “Bond ETFs Suffer from Pricing Discrepancies:”

Exchange traded funds (ETFs) have many of the built-in advantages that mutual funds have, but there are also differences. In my view, the biggest difference is not the fact that ETFs trade throughout the day or even how ETF pricing works, but rather that ETFs have a very short operating history.

We use both mutual funds and ETFs so I am not at all negative about exchange traded funds, but I am aware that there will be growing pains as the ETF industry matures.

In this piece from the Wall Street Journal [registration may be required], we see problems arising in bond ETFs. Namely, that it is hard to price some of the underlying bonds in the various ETF portfolios accurately. Or, it may be difficult for a given ETF to replicate a bond index exactly because the index may hold some bonds that are not traded frequently.
...

…Share prices of many bond ETFs are drifting far from the value of their underlying holdings, which can create big trading costs for investors. Some of the funds are straying from their benchmarks, meaning investors aren’t getting the returns they expected.

…ETFs, typically cheap, straightforward products designed to act like index funds, generally track the performance of a benchmark for stocks, bonds or commodities. But they differ from traditional mutual funds because they trade throughout the day on an exchange.

Keeping ETF returns in line with the indexes has proven to be tough in the murky bond market…

…State Street Corp.’s SPDR Barclays Capital High Yield Bond ETF (JNK) fell nearly 1% in the 12 months ending Aug. 31, even while its benchmark gained 6%…

…The iShares iBoxx $ High Yield Corporate Bond ETF (HYG), for example, traded at a 7% premium at one point in April, and traded within 0.5% of its NAV on only five days in the third quarter…

Such wide gaps aren’t generally supposed to appear in ETFs. Big investors can typically buy up the fund’s underlying holdings and swap them for ETF shares, arbitraging away any significant gaps between the ETF share price and NAV.

But bonds can be so tough to trade that large investors become reluctant to perform this function for fixed-income ETFs. Even when they do make the trades, they incur big trading costs that get factored into the price of the ETF shares…
...

Bond ETFs set the NAV based on estimates of the prices they would get if they sold their holdings. Meanwhile, most bond ETFs are bringing in new money now, so the dealers responsible for creating ETF shares need to constantly buy new securities. That takes place at the higher “offer” side. To compensate, dealers will price the ETF shares higher than NAV, resulting in the bias toward a premium.

If it’s a matter of buying and selling at inflated prices, it’s a wash. But sometimes, investors who bought at a premium end up selling at a discount. “If everybody is selling, it’s also a time where there may not be much liquidity in the bond market, and…funds will be trading at NAV or at a discount to NAV,” says Kenneth Volpert, a principal at Vanguard Group.

In fact, when investors fled corporate bonds last fall, many bond ETFs traded at meaningful discounts. This year, some $25 billion has gone into bond ETFs, a good portion of which is chasing big returns in high-yield bonds, which are notoriously difficult to trade in tough times. How would ETF prices handle that money being pulled out in a flash?…

So far, the discrepancies between a given ETF’s share price and its net asset value (NAV) seem to be manageable. As anyone who has ever purchased bonds knows, bond traders do a good job of exacting their pound of flesh, particularly for thinly-traded securities. So, the cost of putting together a portfolio that matches a given index would be very difficult and costly.

This last point is a good one though. If all the investors in a given ETF want to get out at the same time, raising cash may be an issue. And, if a given ETF has to raise a lot of cash quickly, it will probably get dinged a bit on those securities that it sells.

[Emphasis added]

While there is no good way to deal with this pricing issue, you might want to consider no load mutual funds if your mode of operation is to generate income.

However, in a zero interest rate environment, the risk in bonds, bond ETFs and bond mutual funds is clearly to the downside, especially if inflation rears its ugly head somewhere down the line.

While there is no perfect solution to deal with this issue, I would never hold any of these funds/ETFs without the use of a trailing sell stop.

When the tide turns and interest rates rise, you want to be one of the first heading for the exit doors before they become too crowded. A trailing sell stop may just be the vehicle to get you there before the masses wake up and follow suit.

Sunday Musings: Missing The Point

ulli-niemann@att.net (Ulli...The Wall Street Bully) — Sun, 08 Nov 2009 13:32:00 +0000

A few days ago, I posted about Schwab’s venture into “Commission Free ETFs.”

While I think that this move is a great step in the right direction, most readers who commented missed my point entirely by being more concerned about venting petty grievances.

In case you don’t remember, back in 1992, Schwab was the innovator when they created the mutual fund market place, which allowed you to have one brokerage account and invest in thousands of mutual funds, many on a no transaction fee basis. It was an unheard concept, which caught on quickly and has since become the standard for any brokerage firm.

While Schwab for a number of years, due to internal policy and management changes, lost that leadership, I believe that they now have stepped up to the plate again by being the first to offer commission-free ETFs with very low annual fees.

To be clear, this is not meant to be a plug for Schwab on my part. I believe that if they can succeed with their efforts of offering a wide variety of commission-free ETFs over the next couple of years, they will have an impact on all competitors. It may lead to others having to follow in the same footsteps, which eventually may result in no commissions (or extremely low ones) at all brokerage houses.

Looking at the big picture, every investor will be served well by this potential outcome no matter where you prefer housing your assets.

How To Track Your Sell Stops

ulli-niemann@att.net (Ulli...The Wall Street Bully) — Sat, 07 Nov 2009 13:42:00 +0000

A convenient and efficient way to track sell stops has been on many readers’ minds. Tom had this to say:

How can I get a fund or ETF price automatically downloaded into my personal investment spreadsheet?

Setting sell stops based on new highs, etc. requires finding the price and manually entering it in the spreadsheet everyday. When I don"t look every day, I know I miss something.

Is this possible without subscribing to some high priced electronic quote system, etc.? (Free is good!) It seems with the tracking you do, there must be an obvious way to do this that I overlook.

I have Schwab and Fidelity, but I have not found a way to do this from their websites. There must be some software, program, or website that will pick up this info and put it into a spread sheet on your PC.

For many years, I have used a simple way to get that task accomplished. I have set up “My Yahoo” as a personalized page to track daily news events. Part of that set up includes a listing of funds/ETfs that I currently own and follow on a daily basis.

The funds/ETFs are listed by ticker, date, price and change for the day as the table above shows. It also includes a feature that lets you export this list to a spreadsheet, neatly arranged in columns to be copied and pasted wherever you like.

In your spreadsheet, you could use Tab1 to paste in all data, as I do, and use Tab2 to have your current holdings listed and formatted. By linking the prices in Tab1 to Tab2, you only need to go though one copy and paste process and your holdings are instantly updated.

Afterwards, I simply view my column titled high price to see if it needs updating, which I do manually. This obviously only comes into play during a market rally when new highs have been made.

Here’s what my matrix looks like using an actual purchase and a sell stop that got triggered:

[Double click to enlarge]

The columns are pretty self explanatory. The “High” column needs to be updated when prices make new highs, while the “Action” column is programmed to alert me to any changes in the status. In other words, when the 7% sell stop level has been broken, the “Hold” switches to “Sell,” giving me an easy identifiable alert when looking at a large list of items.

While I use other custom data bases to track these sell stops for a large number of funds/ETFs, this spreadsheet along Yahoo’s export feature is simple and effective and requires minimum time on your part once it is set up.

No Load Fund/ETF Tracker updated through 11/5/2009

ulli-niemann@att.net (Ulli...The Wall Street Bully) — Sat, 07 Nov 2009 00:55:00 +0000

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

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

Our Trend Tracking Index (TTI) for domestic funds/ETFs has now crossed its trend line (red) to the upside by +7.52% keeping the current buy signal intact. The effective date was June 3, 2009.

The international index has now broken above its long-term trend line by +12.24%. A Buy signal was triggered effective May 11, 2009. We are holding our positions subject to a trailing stop loss.

[Click on charts to enlarge]

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

Commission Free ETFs

ulli-niemann@att.net (Ulli...The Wall Street Bully) — Thu, 05 Nov 2009 12:58:00 +0000

Charles Schwab Corp. has finally entered the crowded Exchange Traded Fund arena as MarketWatch reports in “Schwab lists first ETFs:”

The financial-services giant, which boasts nearly 8 million brokerage accounts, listed four ETFs on the NYSE Arca exchange. The ETFs, which are baskets of securities that trade like individual stocks, feature low fees and represent a clear challenge to industry heavyweights State Street Corp., Vanguard Group and Barclays Global Investors, which is being acquired by BlackRock Inc.

Schwab is trying to jumpstart its ETF business by offering commission-free online trades for its clients.

Peter Crawford, senior vice president at Schwab, in a telephone interview Tuesday said the ETFs' low expense ratios and free trading offer "an incredible price" for investors. Schwab, which has about $1.3 trillion in client assets, will benefit from its strength as a mainline distributor of financial products, he said.
...

The inaugural Schwab ETFs that listed Tuesday are Schwab U.S. Broad Market ETF (SCHB) , Schwab U.S. Large-Cap ETF (SCHX 24.82) , Schwab U.S. Small-Cap ETF (SCHA) and Schwab International Equity ETF(SCHF) . The first two have expense ratios of 0.08%, while the others charge 0.15%.

They undercut similar ETFs on price, and any pressure on competitors to cut fees is a welcome development for investors, experts say.

For example, the largest ETF, State Street's SPDR S&P 500 ETF (SPY) , has an expense ratio of 0.09%, as does the iShares S&P 500 Index Fund (IVV). The Vanguard Large-Cap ETF levies fees of 0.13%.
...

Crawford, the Schwab executive, said the firm's ETF push will be helped by its client relationships, particularly its network of about 6,000 independent advisers. Even before it launched its own ETFs, Schwab was a major trading platform for the products and the company estimates between 20% and 25% of retail ETF assets are held by Schwab clients.

The company plans to roll out four more broad-based stock ETFs next month, tracking U.S. large-cap growth, U.S. large-cap value, international small-caps and emerging markets. The tracking indexes are maintained by Dow Jones and FTSE.

Crawford declined to comment on specific plans for additional Schwab ETFs, citing regulatory restrictions. However, he said the company will focus on "the major categories, which account for the bulk of assets," rather than niche products.

"There's nothing fancy about the new Schwab ETFs," said Gabriel, the analyst. There are already a "plethora" of similar funds on the market, so Schwab will compete head-to-head with industry leaders BGI, State Street and Vanguard.

"With little differentiation among ETFs offering similar exposures, Schwab's strong brand name and its product pricing will be critical to the firm's success in the budding ETF industry," Gabriel wrote in a recent Morningstar commentary.

"Investors should welcome Schwab's entrance into the ETF universe," he added. "While there's nothing earth-shattering about the exposures offered by the new Schwab ETFs, the relatively low expenses that Schwab plans to charge should at least keep the big boys in the industry honest."

[Emphasis added]

I always welcome new products in the ETF marketplace, especially when they are being introduced with lower costs to investors. Even though, I use Charles Schwab & Co. as custodian for my clients’ assets, I will not immediately jump at these new offerings.

My reasoning is the same for all newly created ETFs. I want to see price history for some 6-9 months so that I can better evaluate the trend. At the same time, I want to make sure that enough interest has been created so that the volume has increased to acceptable levels.

To invest in any unproven ETF with low volume is simply asking for trouble. The bid/ask spreads are high, and you may not be able to liquidate your holdings quickly without too much slippage in price.

In other words, you are giving up control, which is something we as trend followers try to avoid.

Misunderstanding The Trend Tracking Index

ulli-niemann@att.net (Ulli...The Wall Street Bully) — Wed, 04 Nov 2009 13:53:00 +0000

Reader Tom had this comment:

A provoking question I thought about is: How do I get a fund or ETF based on your TTI? An ETF or fund with the return of your Domestic TTI of 8.53% would be nice.

Tom is missing the purpose of the Trend Tracking Index (TTI). It is designed to determine market direction so that we can easily identify whether the overall long-term trend is up or down. Nothing more and nothing less.

The TTI does not have a return. The percentage stated is simply its current position above or below its trend line, which changes daily with the market movement. It does not represent any gain or loss.

To see how domestic ETFs have fared since our latest Buy signal on 6/3/09, simply reference the StatSheet. If you look at the latest issue, you will note the second column from the right titled “Since 6/3/09.” That represents the performance for this cycle.

To sum it up, use the TTI first to determine market direction and then the StatSheet to select funds based on momentum rankings. Keep in mind that it is not always advisable to pick the top ranked funds/ETFs. While they will give you great firepower, if the markets move your way, they will also give back any gains the fastest when a pullback occurs.

I personally always drop down in the fund/ETF pecking order to find those that give me the best of both worlds: Decent gains and some resistance to sell offs.

Losing Steam

ulli-niemann@att.net (Ulli...The Wall Street Bully) — Tue, 03 Nov 2009 13:44:00 +0000

One look at the chart tells you that yesterday could have been a real bad day in the markets. An early rally of 145 points in the Dow was completely wiped out as the markets briefly dipped into negative territory as a result of a sharp sell-off in the financials.

Things looked pretty bleak at that moment; however, decent economic news proved to be the savior and a rebound and pulled the major indexes out of the doldrums. Uncertainty about market direction is bound to continue especially in view of the Fed meeting and Friday’s all important employment report.

I took the opportunity today to liquidate those holdings which had triggered their preset sell stop points during last Friday’s drubbing. Only time will tell if this move is in sync with the overall trend. If not, and the markets resume upward momentum, I will look for new entry points. For the time being, I am comfortable with a little less exposure to equities.

As an aside, Mish at Global Economics wrote a nice piece titled “Is Debt-Deflation Just Beginning.” It’s a bit lengthy but well worth the read if the deflation/inflation scenario is of any interest to you.

I am in the camp of those who believe that deflation will be with us for years to come, before any inflationary scenario can actually play itself out.

Sell Stops For All Positions All Of The Time

ulli-niemann@att.net (Ulli...The Wall Street Bully) — Mon, 02 Nov 2009 13:29:00 +0000

In response to a recent post, reader Don provided this feedback a week ago:

This is in response to "How High Can We Go", and the current overbought condition of the market. John Hussman has a superb article on this, which you can read here.

The title alone got my attention: The Stock Market Has Never Been This (Intermediate-Term) Overbought.

As a result, I've looked over all of my holdings and tightened up my stops, at least to just under the early October lows before we went to new highs.

But I have a related thought, for what it's worth. I too have looked at thousands of charts over the last few decades, and have read the key works on charting, and as important as the basic concepts may be, I believe it's essential to allow for the occasional Black Swan.

I have seen a handful of charts in my life that are similar to your current TTI index, which were the basis of liquidating my long positions (and even going short in some cases), which were followed by gaps to new highs (above the high point on your chart), which caused devastating losses for my short positions, not to mention a whole lot of wailing and gnashing of teeth over the profits not made on my prior bird in the hand long positions.

In terms of how to deal with the current market, instead of just making sure that one has stops in place because it's likely that the market's going to roll over soon, I think one should have stops in place all the time--including, and perhaps especially--in those markets in which it appears least likely that they're going to roll over.

[My emphasis]

Yes indeed, the article by John Hussman is a worthwhile read.

Take a look at the highlighted sentence again. I want to make sure that there is no misunderstanding. Whenever you initiate any position (other than money market), you need to track your trailing sell stops no matter what the appearance of market behavior tells you.

Reader Don seems to imply that he does not have stops in place for those holdings that don’t appear likely to roll over, as he puts it.

That is not correct. If you are working with sell stops, the rule simply is to “track sell stops for all positions all of the time.” Never get caught without one, because you don’t know when and where the next shoe will drop.

Sunday Musings: A Down Decade

ulli-niemann@att.net (Ulli...The Wall Street Bully) — Sun, 01 Nov 2009 13:31:00 +0000

Most investors don’t realize that market returns, as measured by the S&P 500, are in negative territory for this decade.

In other words, even money under your mattress would have done better than having been invested on a buy and hold basis in the major indexes.

MarketWatch featured a story on the subject a month ago, but it is still as valid as it was then, especially with the markets having been in correction mode recently. Take a look at some highlights of “To finish the decade in the black, S&P has its work cut out:”

After back-to-back 15% gains that made for the best two quarters since the first half of 1975, the S&P 500 Index needs to advance another 39% for the index to break even for the decade.

On Thursday, the odds of that scenario panning out seemed even more dicey, with the U.S. stock market starting off the first day of the final quarter of the year by taking its biggest single-day hit since the prior quarter began.

"Thirty-nine percent is an enormous amount," said Howard Silverblatt, senior index analyst at Standard & Poor's. "I would not want to take that bet."
...

The stock market has "gone a long way without a correction," added Silverblatt, who also pointed out the S&P 500 would need to advance 159% in the final three months of the year "to beat your brother-in-law who put the money in a 10-year Treasury."

Again, Webb concurs. "On Jan. 1, 2000, the 10-year bond yield was at 6.66%. Today it's at less than half of that, at 3.19%. And what has the equity market done for you? Fixed-income would be preferable," said Webb.
...

While volatile, U.S. equities have basically "gone nowhere over 10 years, although it's been a hell of a wild ride in between," said Webb.

Among the S&P's 10 industry groups, energy advanced the most from Dec. 31, 1999, through Sept. 30, 2009, with the sector climbing more than 92% and in need of a 48% drop to finish the decade at neutral. Conversely, telecommunications fell more than 66% during the not-yet-finished decade, with the sector in need of a 198% boost in the final three months to break even.

Sure, the market rebound of 2009 has been impressive by any measure, but for the S&P to gain an additional 39% in the next 2 months is highly unlikely. It only took two bear markets in 10 years to destroy portfolio returns, which supports my view that is far more important to avoid the big drops in the market than to be permanently invested in the “best” funds.

With the recent pullback, even the odds of the S&P reaching the level of our sell signal on 6/3/08 (1,318) are remote at best. As of Friday, the S&P (1,036) would have to gain over 27% just to get back to that break even point.

Chances are pretty good that, given the general state of the economy, the next decade will bring more of the same.

Personally, I believe that we will see more stunning rallies, as the economy allegedly improves, only to be followed by jaw dropping pullbacks as reality proves otherwise. In other words, recoveries based on the “WW” concept (up-down-up-down) are very likely in my opinion. As a result, those investors simply buying and holding will again be left holding an empty bag.

Follow the trends unemotionally, get in when the markets confirm upward momentum, and get out when your trailing sell stops tell you to do so. This will be your best opportunity to deal with the ever increasing uncertainties in the market place.

Subjective Reasoning

ulli-niemann@att.net (Ulli...The Wall Street Bully) — Sat, 31 Oct 2009 12:55:00 +0000

With the market having sold off sharply last Wednesday, several sell stops were triggered causing reader feedback.

Here’s one comment, which came in Thursday morning as a rebound was underway:

EWZ has a big rebound from yesterday's sell signal to this morning's 6+% rise. I'm going to hold on to that one. Do you ever change your mind (from strict sell stop discipline) on any like that?

Absolutely! This is one more reason why I don’t ever enter sell stops ahead of time. You have to use some common sense or subjective reasoning, as I like to call it, before putting in your sell orders.

I touched on this before, but here’s my process again. After the close of the market on Wednesday, several sell stop points had been reached requiring action the next day. I prepared my sell orders and watched the market opening on Thursday. A rebound was in the making, and the major indexes already had moved up some 0.75% so I held off placing any orders.

As the morning progressed, and the main news of a positive GDP supported accelerating upward momentum, I decided that the odds of a higher close were pretty good.

As a result, none of my planned sell stops were entered. Only time will tell, whether this was a wise decision or not and if indeed this holding back prevented a whip-saw signal.

On the other hand, Thursday’s rebound could have been a one-day event, with the markets subsequently trending lower stopping me out a day or two later anyway. So be it. You have to realize that the use sell stops is not an exact science and probably imperfect in many ways.

Still, you need to use them as best as you can, because there is no other way I know of to successfully circumvent severe directional market downturns.

No Load Fund/ETF Tracker updated through 10/29/2009

ulli-niemann@att.net (Ulli...The Wall Street Bully) — Fri, 30 Oct 2009 23:52:00 +0000

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

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

The bears spanked the bulls this week as poor economic reports pulled the major indexes lower.

Our Trend Tracking Index (TTI) for domestic funds/ETFs has now crossed its trend line (red) to the upside by +6.63% keeping the current buy signal intact. The effective date was June 3, 2009.

The international index has now broken above its long-term trend line by +10.97%. A Buy signal was triggered effective May 11, 2009. We are holding our positions subject to a trailing stop loss.

[Click on charts to enlarge]

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

Heading South

ulli-niemann@att.net (Ulli...The Wall Street Bully) — Thu, 29 Oct 2009 11:39:00 +0000

The markets continued to stumble yesterday as downward momentum accelerated. Much has been written about a potential market top and one of the more interesting observations and references was made by Mish at Global Economic Trends in a post titled “Multi-year Stock Market Top could Be In.”

With yesterday’s action, several sell stops were triggered, and the affected holdings will be liquidated today. The position of the Trend Tracking Indexes (TTIs) relative to their long-term trend lines is as follows:

Domestic TTI: +7.14%
International TTI: +11.18%
Hedge TTI: +0.54%

Over the past month, continued reader feedback regarding sell stops was a topic of great interest. A few days ago, reader Bob had this to say:

Market is getting a bit testy right now. I noticed that my holding in Russell 2000 ETF is down 5.69% from its high today.

My question is do you recommend using 7% or 10% stop for this type of holding since its Beta is 1.19 compared to S&P 500 per Morningstar?

Another though I had was to use a stop of 8.5% (7% x 1.19) to account for its increased volatility. In fact I am considering doing this for all of my holdings. It is easy to do & follow with spreadsheet I have set up. I would probably round all exit calculations to the nearest 0.5% (as I did above) to make it easier to follow in the sell zone.

While that is a different way of applying the sell discipline, it does not really matter. My preference is to use the 7% rule for all domestic and international funds and 10% for the more volatile country and sector fund arenas.

You should use whatever approach you are most comfortable with. In the bigger scheme of things, using any type of sell stop discipline is better than using none at all.

Remaining exposed to the whims of the market place with no clear exit plan has proven to be disastrous in the past and may very well be the downfall for many investors again in the future.

Reader Sell Stop Question

ulli-niemann@att.net (Ulli...The Wall Street Bully) — Wed, 28 Oct 2009 12:11:00 +0000

As the markets begin to show signs of weakness, questions about the sell stops keep coming in. Here’s one from a reader asking for clarification:

You also suggest selling a fund if it has dropped more than 7%from its most recent high. My question is, if a most recent high occurred in May this year and the fund/ETF is down more than 7% now since May, do you still consider it a sell? What if it was bought since May (maybe shouldn't have)?

It’s not the recent high, or the high since May, that a fund/ETF has made that’s important. It’s the high that was made since you bought it that counts.

When using a trailing stop loss, which will limit your losses and/or lock in your gains, only the price action, which occurred after your purchase is of any relevance. To be clear, what a fund/ETF has done in the past in terms of price movement maybe a consideration in your selection process, but has nothing to do with the execution of the sell stop discipline.

Once you have made the purchase, only then will the tracking of the closing prices going forward form the basis for your exit points—not before.

Front Runners

ulli-niemann@att.net (Ulli...The Wall Street Bully) — Tue, 27 Oct 2009 12:26:00 +0000

Seeking Alpha featured an interesting piece called “How Traders Are Front-Running ETFs:”

Another aspect of exchange-traded funds (ETFs) coming to the fore lately is front-running. That’s the practice where traders buy ahead of large orders from ETFs and short sell ahead of large sell orders. They scalp profits by flipping their newly acquired long positions back to the ETF at higher prices and closing their short position at lower prices. The ETF ends up paying more to buy securities and receiving less to sell; in effect, traders have transferred profits from the ETF to themselves.

The practice has been a fixture of ETFs since they were first invented. Any time an index maker announces a change to the underlying index it is an all-points bulletin that the ETF fund will be entering the market to buy the added securities and sell the deleted ones. In the case of broad-based ETFs, the extent of the profit transfer likely isn’t too significant because the index changes usually affect just a small portion of the basket.

But the story changes as one departs from plain vanilla, broad-based ETFs. Of note, the more markets are sliced and diced into smaller slivers for ETFs to track, the more likely index changes will become significant in relation to the index basket. And, in turn, so does the opportunity for front-runners to transfer returns from ETF holders to themselves.

This is one of the reasons why I never place sell stops ahead of time as “stop orders.” I don’t want to get stopped out because of alleged front running activities or simply other intraday market noise.

I suggest you do the same by using “day-ending closing prices” only to see if any sell stop has been triggered. If it has, only then do I enter my order the next day.

This avoids intra-day whip-saw signals and simplifies my tracking. In other words, I treat ETFs like mutual funds in that, for sell stop purposes, only one price per day exists.

No Post

ulli-niemann@att.net (Ulli...The Wall Street Bully) — Mon, 26 Oct 2009 08:16:00 +0000

Due to my travels back from Germany, there will be no post today. Regular posting will resume on Tuesday.

Sunday Musings: Dead Men Walking

ulli-niemann@att.net (Ulli...The Wall Street Bully) — Sun, 25 Oct 2009 11:12:00 +0000

Despite the market’s sharp rebound off the March lows, I have questioned the fundamental reasons on which this alleged economic recovery was based.

To me, it was nothing but government stimulus along with wishful thinking that supported this move into the stratosphere. What happens when the stimulus ends?

My concern has always been that a recovery, such as we’ve seen, can never have staying power unless it is accompanied by job growth. While job growth is considered to be a lagging indicator, I simply can’t see any job creation because of rampant overcapacity in most industries.

One hedge fund manager has similar concerns in “Hedge manager Sprott sees trouble when easing ends:”

When so-called quantitative easing by central banks ends, the world economy may slip back into trouble, Canadian hedge fund manager Eric Sprott warned on Tuesday.

Toronto-based Sprott called Citigroup, Fannie Mae, Freddie Mac, and General Motors "dead men walking" in late 2007. On Tuesday, he said the U.S. government is the new dead man walking, partly because it may struggle to keep borrowing enough money if the Federal Reserve stops buying Treasury bonds.

Sprott's Canadian hedge fund, Sprott Hedge Fund LP, is up more than 400% since inception in 2000 as it rode a surge in gold prices and shares of gold miners and other raw materials companies.

Bank bailouts and other dramatic efforts by central banks have stopped the world "going into the abyss," Sprott said during a presentation at the Value Investing Congress in New York.

The "granddaddy" of all those bailout efforts is quantitative easing, in which central banks in the U.S. and the U.K. especially buy government bonds to keep interest rates low, Sprott said.

The U.S. government has raised roughly 200% more by selling bonds this year, versus last year, Sprott noted. Through the end of the second quarter of 2009, he said the only major buyers of these government bonds were central banks.

"When quantitative easing ends, what's going to happen?" he added, noting that there are already two clues to answer that question.

When the U.S. government's cash-for-clunkers program ended, car sales slumped. Meanwhile, as the end of the government's first-time homebuyer incentive approaches, recent data suggest weakness building again in the housing market, Sprott said.

Roughly 35% of all homes bought in the U.S. recently were purchased through the incentive program. If it is not extended, December home sales could slump 25%, Sprott estimated.

Sprott remains concerned about banks and other financial institutions in the U.S., because he thinks they remain too leveraged.

Banks leveraged roughly 20 to 1, have about 5% of equity supporting mostly paper assets. If those assets fall by more than 5%, the institutions are effectively bankrupt, Sprott said.

I agree with his assessment. While there is nothing about the potential outcome you and I can do, it helps to be aware of the likely consequences, even though we may be entering un-chartered territory.

I believe the market at current levels has more limited upside potential, but poses tremendous downside risks. Again, as trend followers, we don’t predict or worry about which way the trend will turn.

If continued government stimulus occurs, we will most likely run with the bulls. If not, and the trend reverses favoring the bears, we will let our trailing sell stops guide us as to when to exit.

While I am singing the same old tune, I believe it’s crucial to have a plan in place so you don’t end up like the buy-and-hold crowd, because they’re doomed to repeat the mistakes of 2008 again.

How High Can We Go?

ulli-niemann@att.net (Ulli...The Wall Street Bully) — Sat, 24 Oct 2009 11:28:00 +0000

If you look at the chart of the domestic Trend Tracking Index (TTI), it’s obvious that the market has rallied since March without regards to the laws of gravity—so far.

The million dollar question is “how high can we go?” Every investor expects a serious pullback, but so far it has not happened. Maybe the chart of the TTI can give us some clue as to where a (temporary) top may occur.

When the markets headed south last year, and entered freefall mode, 2 gaps were created on the domestic TTI (see red arrows) price chart. Since they occurred to the downside, they are called exhaustion gaps, meaning that selling activity far outpaced buying activity.

Chart technicians will tell you that gaps will always be closed. In this case, that would translate to prices moving to a point that is higher than the beginning of the gap opening. The lower gap (lower red arrow) has been closed already, and we’re now half way (44.00 price level) through closing the upper gap. This process would be completed at around 44.50.

Having looked at thousands of charts over the past 20 years, this pattern occurs with regularity, the big unknown is always the timing of it. Just because the exhaustion gaps occurred last year does not mean they will be closed this year. However, we seem to be on track with the TTI only having to move up another 1.14% from the 44.00 level.

Here’s the rub. Once the closing of the gap occurs, odds are high that the trend will reverse. However, as anything that has to do with investment concepts, nothing is 100%.

This is not a prediction on my part; it’s simply a pattern that I look at from time to time to try to get some sense as to how high we could go. So, let’s watch out for the 44.50 level.

If this nugget of wisdom does not play out, there is a good chance that still higher prices are ahead.

No Load Fund/ETF Tracker updated through 10/22/2009

ulli-niemann@att.net (Ulli...The Wall Street Bully) — Sat, 24 Oct 2009 09:50:00 +0000

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

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

Whip-saw moves left the major averages with slight losses for the week.

Our Trend Tracking Index (TTI) for domestic funds/ETFs has now crossed its trend line (red) to the upside by +8.53% keeping the current buy signal intact. The effective date was June 3, 2009.

The international index has now broken above its long-term trend line by +14.90%. A Buy signal was triggered effective May 11, 2009. We are holding our positions subject to a trailing stop loss.

[Click on charts to enlarge]

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

Reader Feedback

ulli-niemann@att.net (Ulli...The Wall Street Bully) — Thu, 22 Oct 2009 11:28:00 +0000

Recently, reader Vermcj had some interesting comments regarding sell stops and his experiences. In case you missed it, here’s what he said:

So, I stick with closing prices as the best way, for me, to determine when my sell stops has been hit, even though I don't know of any computer program or brokerage firm+ that will calculate closing prices as daily sell stops.

And I believe your financial advisor or you, if you don't have a financial advisor, have to look at your sell stops EVERY day. I believe if you, or if you don't have a financial advisor like Ulli look at your sell stops every day, or if you do your own trading and don't have enough time to evaluate your sell stops EVERY DAY and make changes in your sell stops, EVERY DAY, then you don't have enough time to be managing your portfolio, because you aren't giving the proper amount of time to properly manage the very basic aspects of it.

I believe that poor choices in stocks, ETFs, mutual funds, futures, and options are more forgiving than ignoring stop sells.

[My emphasis]

I agree. It’s important that you track your sell stops on a daily basis, especially if the market heads higher so that you can capture the new high price of your holdings. This new high price will form the basis for calculating the 7% trailing stop loss. On minor pullbacks, you can check price action, but there will be nothing else to do.

If you set up your tracking on a spreadsheet, this should take no more than a few minutes a day.

Look at the highlighted sentence above. I agree wholeheartedly that a poor selection of funds/ETFs is more forgiving than ignoring sell stops. The reason is obvious: A poorly selected fund may turn out to be a lagging performer, while not paying attention to sell stops can ruin years of investing.

That’s the lesson of 2008. Unfortunately, millions of investors had to learn this fact the hard way.

Disagreement

ulli-niemann@att.net (Ulli...The Wall Street Bully) — Wed, 21 Oct 2009 09:48:00 +0000

Yesterday’s post about a different type of sell stop generated some reader feedback. As always, I appreciate the commentary; although I don’t necessarily agree with all opinions.

Here’s one comment that I feel needs clarification:

Something that you definitely are missing when talking about trailing stops is the Market trend.

If the Market indicators are Bullish, one really should think twice about selling an ETF/Mutual fund on a 7 percent down turn. Had I not used common sense and not sold my ETFs/Mutual funds on a 7 percent down turn, I would have missed out on the 50 percent bull Market run over the last 7 months. I believe you have also advocated using common sense/intuition before selling mutual funds/ETFs.

The reason to use trend tracking along with trailing sell stops in the first place is to have a clear cut plan in place in order to avoid emotional decision making and to control downside risk.

If what you are describing works for you, fine, but it may not work for others. Introducing another subjective variable, such as the identification of the market trend (however you want to define it), causes additional decision making and confusion.

To be clear, when a trend for an ETF/Mutual fund ends, reverses and triggers my trailing sell stop, we get out. At that moment, however, we have a plan in place as to what will have to happen in the market in order for us to re-enter. If you don’t have such a plan, yes, then you will miss out on the potential upside.

2008 was a perfect example in that by most measures the market was still in an uptrend when we moved to the sidelines on 6/23/08. My preference is to act immediately when the signal gets triggered and ask questions later.

As I have often commented, being disciplined and exact with the execution will lead to whip-saws from time to time. That’s the price we simply pay to be sure we avoid the big drops in the market whenever they happen.

Since you apparently use a sell stop along with an analysis of the market trend, I’d be curious to know when you got out last year and when you re-entered this year.

My philosophy over the past 20 years has been to keep things consistent, effective and simple without any attempt of curve fitting my approach to current market conditions.

A Different Sell Stop

ulli-niemann@att.net (Ulli...The Wall Street Bully) — Tue, 20 Oct 2009 10:55:00 +0000

Discussing the sell stop strategy has been the hot topic over the past few weeks and for good reasons. It’s one of the most important aspects of keeping your portfolio intact when the trend reverses.

There is not just one way to use sell stops as reader SS commented:

I disagree to an extent. If you have a diversified equity mutual fund portfolio, there is no reason why you can't just have a trailing stop on the entire portfolio.

It's easy to track which funds are doing well vs their category and which classes are doing well overall. If one is really underperforming you can just swap it for something that's better. It really depends on your philosophy.

You can use the S&P as you gauge if you'd like. The S&P high is 1072 ytd...if you use 10% of that high, or whatever becomes the high, as your trigger to exit.... you know at what point there are probably some fundamental issues in the economy and you should likely get out. The caution is be careful about setting a trigger too low. The market could drop off 6-7% and still be fundamentally sound. And you don't want to be in and out of the market needlessly. The best thing is this alternative is much less labor intensive than tracking every fund.. for both clients and advisors:)

To each his own. Using the S&P as a gauge for setting sell stops can be a dangerous game. Why? For the simple reason that it may drop at a slower pace than your portfolio, which, as a consequence, may lose more than your intended percentage.

Again, there are many ways to work with sell stops. You need to find the one approach that you are most comfortable with. Looking at the big picture, any type of sell stop will be better for your financial health than none at all.

Correction Worries

ulli-niemann@att.net (Ulli...The Wall Street Bully) — Mon, 19 Oct 2009 12:31:00 +0000

Reader Mel has invested $1.1 million with 45% allocated to the domestic market, 30% to the international arena and 15% to bonds and other small holdings.

Here’s a portion of his comment:

As the market heats up, I worry we may be in for a big correction. I am 70 years old and plan to retire in 3-4 years. Can you provide any advice? If you only do this for a cost, I'd like to know more about that. I manage all my Fidelity holdings. Thanks.

The important point here is not to belabor as to whether his allocations are correct for his particular circumstances, most of which are not known at this point.

Markets are so intertwined and correlated these days that many (if not all) allocation models are pretty useless anyway once the trend heads south again. Most did not learn this lesson last year, or in 2001 for that matter, so the same mistakes will be repeated.

The most important thing that Mel can do is to set up his trailing sell stops for all of his holdings so that his portfolio stays intact for the most part when the next correction materializes. With the current economic backdrop, I do not see this alleged recovery continuing forever, so a meaningful correction will be a virtual guarantee—the timing of it is the big unknown.

Anyone with any type of portfolio needs to protect himself against too much downside risk. The best way I know of is via the use of trailing sells stops. I still remember the phone calls from investors like Mel in 2001, who were desperately trying to figure out what to do “after” their $1 million portfolio was slashed in half thereby changing their retirement plans forever.

In that sense, Mel is ahead of the crowd; he realizes the tremendous downside risk and intends to take action “before” serious portfolio damage occurs. I commend him for that and hope that you are doing the same thing.

Sunday Musings: Should You Deploy New Money Now?

ulli-niemann@att.net (Ulli...The Wall Street Bully) — Sun, 18 Oct 2009 13:01:00 +0000

One of the most frequently asked questions recently has been whether it’s too late to deploy new money now given the run-up we’ve had over the past 6 months.

Here’s what reader SS had to say:

Your Domestic TTI now is +9.36 and Int'l TTI now is +11.96. You've talked a lot about the exit and entering strategies.

However, since both the domestic and international TTI is extended too high, is it still good to commit the fresh cash into the both of the markets at this juncture or is it too late?

Reader Don had similar concerns:

Is this a good time to put new money in the market as long as I use a stop loss or is the market too risky at this level to put in money now?

Thanks for your guidance.

Of course, if I had the exact answer, I would be competing with Gates and Buffett for the top spot on Forbe’s list of richest men.

Since I don’t, and no one can predict whether next week will be the start of a market downturn or not, I have to use a different approach.

New money flows into my advisory business almost on a weekly basis. To determine whether it should be deployed or not, I review with a client his risk tolerance along with the possibility of using my incremental buying procedure and sell stop strategy.

For example, let’s assume that a client is just about fully invested but has another $100k he is considering deploying in the market for long-term growth.

My main question to him would be if, after the investment has been made, the market drops and we get stopped out with a 7% loss, will that be acceptable?

If he’s aggressive, he’ll say “yes,” and we proceed accordingly.

If he’s conservative, he’ll say “no,” and I suggest using the incremental buying procedure. In that case, I would initially deploy only 1/3 of his $100k, or $33k. If the market corrects thereafter, and he gets stopped out with a 7% loss, that only represents a 2.3% loss of his total intended investment of $100k.

If that’s acceptable to him, we’ll proceed accordingly.

If it’s not, he should not invest any other funds in the market at this time.

This is a simple, quick and easy process you can use to identify what type of investor you are and whether adding more money to the market goes along with your emotional make up.

Better yet, if you at all have a pit in your stomach trying to make that decision, simply don’t and stay on the sidelines. Your comfort level is what matters most, which is contrary to what many commissioned brokers want you to do.

The TTI As A Short Signal

ulli-niemann@att.net (Ulli...The Wall Street Bully) — Sat, 17 Oct 2009 13:40:00 +0000

Things are so much easier to evaluate with the benefit of hindsight. I was reminded of that when reader Jon sent in this comment:

If the TTI is so accurate, why don’t you short the market when it indicates a major downturn? Why stay on the sidelines when there is money to be made shorting the market, especially now that there are so many inverse ETFs?

It’s not the accuracy of the TTI that will solve all problems for you when intending to short the market; it’s the accompanying volatility that causes frustrations.

Take a look at the blown up chart of the Domestic Trend Tracking Index (TTI) reflecting on market behavior last year:

2008 started with a sell signal on January 18. If you had sold short at that time, you would have been stopped out fairly quickly as the trend reversed and generated another Buy on May 15, which lasted barely 5 weeks until the Sell on June 23.

Shorting again at that time, would have produced another whip-saw, as a rally (upper purple arrow) would have triggered your sell stop again. Sure, the ensuing free wall would have been very profitable but with a sell stop in place, you had no chance to participate.

After the bottom was hit (lower purple arrow), any aggressive shorting during those volatile times would have produced a series of discouraging whip-saws. I know some of clients who attempted such heroics with their “play” accounts, without much success.

The point is, just because many more tools are now available for shorting the market does not mean it’s wise to do so. Personally, I am content with the fact that the TTI gave us a signal to move to the safety of the sidelines, which millions of investors wish they had participated in.

Even after this year’s tremendous rebound, those that followed signal of the TTI are still ahead, since the S&P 500 will need to gain another +17.5% from Friday’s close just to reach the level of our sell signal on 6/23/08.

As the last 20 years have shown, the TTI is a great tool to use when trying to identify changes in market direction. However, when we are entering bear market territory, volatility usually increases dramatically and may make shorting, along with the use sell stops, an endeavor only suitable for the most aggressive of investors.